House of Cards (7 page)

At least two major hedge funds began pulling their cash from the firm. “The prime brokerage withdrawals began in earnest that Tuesday night,” Boyd explained. “I think the two big funds that kicked it all off were Renaissance Technologies—Jim Simons's $30 billion fund. I had two or three people tell me that he pulled, and I think he had $20 billion [at Bear]—and I think Highbridge did, too.” (Since September 2004, JPMorgan Chase has controlled Highbridge Capital Management, a hedge fund with around $35 billion in capital.) To be sure, the cash was theirs and they were entitled to it at any moment, and this cash was not to be confused with Bear's own corporate cash, which was in a separate, segregated account.

“The thing about prime brokerage withdrawals,” Boyd explained, “is if I put in my withdrawal request at 9:00
A.M.
, that cash is back to me, wherever I want it, by 4:00
P.M.
the latest. Wired, okay? It's not like there's a lot of room for negotiation. If a guy's got a $10 billion account with you, you've got to get him $10 billion in assets. Whether it's his five-year position, or his IBM stock, or his cash account, or whatever, it's got to get to him. Now, obviously, what Bear Stearns had done, and every Wall Street firm has done—they don't like you to know it too much—is the securities that were on account there that are held in margin accounts, the hedge fund accounts, they rehypothecated those, so they used those to borrow more money.” To meet the requests of its hedge fund clients for their money, Bear had the stark choice of liquidating some of the assets it had bought with their cash or using some of the firm's own cash. This was very troubling indeed. “I remember Tuesday morning, we were in management committee, and Bruce Lisman got a call, and when he finished he told the committee that Renaissance moved out all the rest of their remaining prime brokerage business,” recalled Steve Begleiter, the head of corporate strategy, a forty-six-year-old Haverford College graduate and, since 2002, a member of the firm's management and compensation committee. “That was a particularly chilling moment because they had been such a long-standing, loyal and significant client. For me, that really crystallized the seriousness of the client flight we were experiencing.”

On one side of the ledger, Bear clients were withdrawing cash as fast as they could. But something equally catastrophic was happening on the other side of the ledger.

“B
EAR
S
TEARNS
I
S
N
OT IN
T
ROUBLE
!”

ne of the other ways Wall Street funds itself on a daily basis is in the so-called repurchase agreement (repo) financing market, where a firm's securities are pledged as collateral for funding. At Bear, the mortgage repo desk arrived at work around six-thirty in the morning. “They dial for dollars,” Friedman said. “Our guys would borrow maybe $75 billion a day, something in that neighborhood, most of it daily. It's not like you're dialing strangers. You're calling up the guy who loaned you the money yesterday and going, ‘You okay with it today? What's the rate today? Okay, great. Thanks.' You tweak it up and down as people need money, and you tweak it up and down as you buy or sell collateral. Basically, the vast majority of it just rolls in the normal course. It's of course insane. In the normal world it would be insane, and in this world it's really insane. But that was the only choice. By the way, it wasn't just us. I guarantee you, if you went to Lehman or Goldman or Morgan Stanley right now, they're doing most of their funding overnight. It's just what they're doing.”

The daily funding drama, such as it is, is usually resolved around eight-thirty each morning. And it is usually an inconsequential discussion, until the moment it's not—and then it can be life-threatening. It would be as simple as being able to breathe one second and not being able to breathe the next. “Most lenders, even Monday and Tuesday, continued to roll,” Friedman continued. “They'd tell you Monday morning, ‘Okay, we're rolling for today. Talk to you tomorrow.' Some of them would say, ‘Listen, I'll roll but I need more margin,' or ‘I used to lend to you and I'd take whole-loan collateral. Now I'll only take agencies,' or ‘I need a higher rate. I need a higher something,' or some of them just said, ‘Hey, I've got extra cash. Do you need it?’”

On Monday and Tuesday, the net effect of these ongoing discussions with the overnight lenders was that the twenty largest firms became increasingly conservative about how they valued the collateral Bear Stearns had been offering them and were demanding more collateral to provide the same amount of financing. “You saw this widening disparity between what we thought we owed them for collateral and what they thought we owed them,” said Robert Upton, Bear Stearns's treasurer. To
a certain degree, disputes among dealers about the value of collateral are normal, but by Tuesday the debate had ratcheted up to a new level. The upshot of the disagreement was that the top twenty dealers believed that Bear Stearns owed them about $1.5 billion more collateral. But the firm disagreed with the market's conclusions and decided not to make the payments. “We didn't make a lot of those margin calls,” Upton said. “So if you think about it, what did that do? That just exacerbated counterparties' concerns.”

During the afternoons at the repo desk—which was just outside of Friedman's office on the seventh floor—a form of the morning discussion would continue when the desk would touch base with the lenders to see whether it looked like the next day's funding would be available. Recalled Friedman: “I'd say, ‘How are we doing?' They'd say, ‘It's okay. Here's what we've seen, but it's okay.' What you'd then find is in the afternoon, a handful of firms would call you and say, ‘Listen, just came out of a credit meeting,' or ‘I just talked to my boss. I'm not going to be there tomorrow for you.' This is Monday afternoon a little bit, Tuesday afternoon more, Wednesday afternoon in a huge way. It grew every day. Every morning, we'd come in and we'd know that there were lenders from the previous day who weren't going to be there. You'd hold your breath, and it would be, ‘Okay. We lost a couple of guys.' We came in with a lot of excess money because we were overborrowing in the anticipation of losing money. We go, ‘Okay, we ate through a little bit of our cushion, but it's okay.' Then, about three o'clock, the repo guys would come in and they'd have this spreadsheet that was a bunch of names—'These are the people who won't be lending to us tomorrow.’” For instance, Fidelity Investments, the mutual fund giant based in Boston, had been lending Bear Stearns $6 billion a day, every day. But that week, Fidelity pulled its overnight funding. Federated Investors, another large mutual fund company, based in Pittsburgh, provided Bear with $4.5 billion in overnight funding on Monday, and then nothing the rest of the week.

Nerves were starting to fray all around at 383 Madison Avenue, especially among the traders, who were the first to hear the rumors as they spread. Bruce Lisman, the sixty-one-year-old co-head of global equities, tried to calm people down. “Let's stay focused,” he yelled to the traders from atop a desk near his fourth-floor office. “Keep working hard. Bear Stearns has been here a long time, and we're staying here. If there's any news, I'll let you know, if and when I know it.” Ace Greenberg performed magic tricks in an effort to keep people amused.

At the same time, Drake Management announced it would likely close its $3 billion Global Opportunities Fund after a series of bad bets
forced the fund to put a hold on redemptions in December 2007. “It would seem more probable that the market disruptions we have experienced will not abate in the short term, but will instead continue for some time,” Drake wrote its investors. In all, “at least a dozen hedge funds have closed, sold assets or sought fresh capital in the past month as banks and securities firms tightened lending standards,” Bloomberg reported on March 12. “The industry is reeling from its worst crisis because bankers— staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market—are raising borrowing rates and demanding extra collateral for loans.”

Still, on the edition of
Mad Money
following the market's 417-point rally on March 11, host Jim Cramer responded to a viewer who asked, “Should I be worried about Bear Stearns in terms of liquidity and get my money out of there?” with a patented Cramer tirade: “No! No! No! Bear Stearns is fine. Do not take your money out! If there is one takeaway other than the plus 400, Bear Stearns is not in trouble! If anything, it is more likely to be taken over. Don't move your money from Bear. That's just being silly! Don't be silly!”

If Cramer had the last word of the night about Bear Stearns, the first word the next morning belonged—finally—to Alan Schwartz, Bear's CEO. Schwartz had emerged from the shadows of the emerging crisis in a live news feed from the Breakers Hotel in Palm Beach. The decision that Schwartz would appear had been made late the prior afternoon in the wake of ongoing speculation about the firm's liquidity position. Prior to his CNBC appearance, Schwartz had just finished interviewing Sumner Redstone, the Viacom emperor, in the hotel's Ponce de Leon IV Room about the wonders of consuming antioxidants and living a long and prosperous life.

Schwartz appeared live on CNBC just after nine o'clock on the morning of March 12. He looked tired and pale but spiffy in his blue-and-white-striped spread-collar shirt and Hermés tie. In his lead-in to the interview—a scoop, to be sure—CNBC's David Faber reminded viewers that it had been a “hard week” for Bear's stock since the firm had been “buffeted by constant rumors of a looming liquidity problem.” Faber's first question to Schwartz was about rumors that Wall Street firms no longer wanted to take counterparty risks with Bear Stearns. Was this true?

“No, it's not true,” Schwartz answered calmly. “There has been a lot of volatility in the market, a lot of disruption in the market, and that's causing some problems administratively on getting some trades settled out, and we're working hard on getting that done. We're in a constant
dialogue with all the major dealers and the counterparties on the Street and we are not being made aware of anybody who is not taking our credit as a counterparty.”

Without naming Kyle Bass at Hayman Capital, Faber then asked Schwartz about the novation that Bass had tried to execute the day before with Goldman Sachs. (Goldman completed the novation on the morning of March 12, around the time of Schwartz's CNBC appearance.) “I'm not aware of a specific trade from one counterparty to another and where we're a third party,” he said. “We have direct dealings with all of these institutions and we have active markets going with each one and our counterparty risk has not been a problem.” Schwartz's answer was counter to the explanation offered by Gary Cohn, Goldman Sachs's co-president, that he had spoken with Schwartz about Bass's novation request.

Where then, Faber asked, had all these rumors originated, especially if they weren't true? “Well, you know, it's very hard to say,” Schwartz replied. “Why do rumors start? If I had to speculate, I would say that last week was a difficult time in the mortgage business. There was talk about problems at GSEs”—government-sponsored entities, such as Fannie Mae and Freddie Mac. “There were certainly some problems with some funds that were invested in very high-quality instruments but on a lot of leverage, and there were some problems there, and some people speculate that Bear Stearns could have some problems in those since we're a significant player in the mortgage business. None of those speculations are true. It's a market that's concerned about things”—and here CNBC anchor Erin Burnett broke into the interview with the news that New York Governor Eliot Spitzer would resign later in the day after revelations about his involvement with high-priced prostitutes.

“So I don't know where the rumors started,” Schwartz continued after the news flash. “Maybe I can just say this: I think that part of the problem is that when speculation starts in a market with a lot of emotion in it and people are concerned about the volatility, then people will sell first and ask questions later, and that creates its own momentum. We put out a statement—I did—that our liquidity and balance sheet are strong, and maybe I should expand on that a little.” Schwartz's comments bring to mind the truism first penned by the financial writer Walter Bagehot, a former editor of the
Economist,
in 1873: “Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.”