House of Cards (78 page)

To their credit, Molinaro and Cayne sought to stop any potentially mushrooming concern about the firm's viability by putting out a press release announcing the firm would hold a conference call for analysts at 2
P.M.
“The stock crashed,” Upton said. “It was basically crashing in the morning. We put the press release out. It went to the Mendoza line”—a reference to the poor .198 batting average of former shortstop Mario Mendoza and used by other players to suggest bad performance. There were 2,200 people on the conference call, eager to understand what was going wrong at the firm. Unfortunately, the call did not work out quite the way Cayne and Sam Molinaro hoped it would. “That was a fucking disaster,” Upton said.

C
AYNE KICKED THINGS
off, as people like to say on Wall Street, by putting into perspective the increasingly difficult market conditions the firm faced. Every financial institution, Bear Stearns included, was facing an extremely challenging market environment. “I've been involved in the securities industry for more than four decades and I have seen a broad spectrum of market dislocations,” he said, “in the stock market crash in the late 1980s, fixed-income troubles in the mid-1990s, and the bursting of the Internet bubble in 2001. This is not the first time and certainly will not be the last time that Wall Street and the financial community will work through difficult conditions. I understand there is a great deal of uncertainty in the marketplace surrounding the operating environment and specifically our firm. I want to assure you that we are taking this situation seriously. We are applying all of the energies and experience we have in the markets to manage the current issues. I'd also like to add that I'm extremely pleased with the way my colleagues have been working to handle this situation.” Cayne made no mention on the call that he was less than pleased by the way Spector had handled the crisis.

Molinaro then made a few comments about the expected profitability of the firm in June and July, “notwithstanding the extraordinarily difficult market conditions,” with “June certainly a hell of a lot better than July.” He also said August would be rough, and if markets returned to some modicum of normalcy, the firm would be profitable, albeit at the low end of expectations. He then asked Mike Alix, the chief risk officer, to talk about how the firm had hedged its exposure to the risky securities on its balance sheet. “In our mortgage businesses, we've put in place a variety of hedges to mitigate the credit risk inherent in our residential
mortgage inventory,” Alix said. He then turned the call over to Upton to discuss the firm's liquidity and sources of financing.

Upton used his time on the call to try to reassure the market about Bear's financial might. He said the firm had approximately $11.4 billion in cash available at the parent company and that, after a concerted effort to reduce the reliance on unsecured commercial paper financing, out-standings had been reduced to $11.5 billion, down from more than $23 billion. He said the firm also had “unused committed secured bank lines” of more than $11.2 billion and $4 billion that could be drawn on an unsecured basis. There was also another $18 billion of “unencumbered collateral” that could be pledged for additional financing. This lengthening of the terms of the firm's financing did not come without a cost—in terms of both higher interest rates and the scars on Upton's back from the internal battles. Upton concluded, all in all, that the firm's financial footing was “extremely solid notwithstanding the current difficult market conditions.” The firm's message was one of preparedness, confidence, and stolidity, everything a bank aspires to be.

But the very fact the firm felt the need to make such reassuring comments made people nervous. The first questioner, Douglas Sipkin, at Wachovia Securities, wondered if Molinaro could explain what had caused the rapid decrease in liquidity in the debt markets in June and July. “There's a great deal of uncertainty in the fixed income markets over the level of default and loss expectations in the subprime mortgage market and … generally in the broader mortgage market,” Molinaro answered. In other words, the world was quickly becoming a riskier place. When would the credit markets normalize? Sipkin wondered. Molinaro said he had no idea what the “catalyst” for a change would be. “We've been in a period of gridlock for quite some time,” he said. “It seems that with each new day and with each new month there's new information in the mortgage market in terms of delinquencies and defaults.”

Sipkin then asked Cayne if he had given any thought to buying back the firm's stock, given its decline to that point in 2007. After a moment of silence, Molinaro said that Cayne had “stepped out of the room,” and in the later reporting of this meeting, the press had a field day with the fact that Cayne had not bothered to stay in the room for the meeting. Some even speculated that the reason he had left the room was to continue the negotiations with Spector—who was not part of the call, either—about his looming firing. The truth was that even though Molinaro told the analysts Cayne had left the room, he was just covering for Bear's CEO. Cayne simply did not know how to answer Sipkin's question. “All heads in the room swiveled to Jimmy, who was still sitting in the room
with Sam,” Paul Friedman said, “and Jimmy went blank like a deer in the headlights. Sam jumped in to save him and said Jimmy had to leave the room. Our vaunted CEO was incapable of answering a single question. I've forgotten the question, but it was pretty much a softball question, too, like ‘What do you see in the markets?' or something like that. It was a nothing question. Jimmy couldn't open his mouth, so he didn't.” Added Upton: “He didn't have his arms around the business. He didn't even know what liquidity was until it started to potentially become an issue. He didn't know who I was, really, until that time frame, and then [he] called me every day. ‘How we doing? How we doing?' So I didn't think very highly of Jimmy, in terms of having his hands on the business and understanding the real risk issues and being able to stand up and make tough decisions when tough decisions needed to be made. It was a lot easier to just abdicate, or make no decision, or filibuster, or talk about the P&L impact, or whatever. We were the ‘House of the Legacy Filibuster'—you've got to get everything perfect, because this is the way we've always done it. We don't want to upset the apple cart, and it's going to cost us more money. What is a filibuster in the Senate? It's a way of forcing a nondecision and extending it until even the most tireless people get tired and give up. So that's all he did.” (In an interview, Cayne said he was
not
in the room.)

T
HE REAL HEADLINES
Molinaro made during the call came moments later, when Mike Mayo, the outspoken analyst from Deutsche Bank, asked about Cayne's remarks in which he suggested the markets were then akin to other financial crises on Wall Street. “Do we compare what you're going through now with those other, more significant times?” Mayo asked.

“I think these times are pretty significant in the fixed-income markets,” Molinaro replied. “I've been at this for twenty-two years. It's about as bad as I have seen it in the fixed-income market during that period of time. This market environment we have been seeing over the last eight weeks has been pretty extreme. And yes, we would make that comparison. I think it is a reasonable comparison.”

The call, of course, went on for another twenty minutes or so after Molinaro answered Mayo's question, but the damage had been done.

“He fucking blew the market up,” Upton said.

That Molinaro thought the collapse in the value of various mortgage-backed securities amounted to a crisis worse than the crash of 1987, the collapse of the Internet bubble, or the meltdown of Long-Term Capital Management—when only a tiny fraction of Wall Street had even started
focusing on the problem—was either a reckless and inflammatory remark by the CFO of a large Wall Street firm or remarkable prescience. Either way, the markets reacted negatively to his comment. “You could watch while he's talking,” Friedman said. “Our stock is going lower and lower by the minute.” Bear's stock traded as low as $106.55, down nearly 8 percent, before closing down 6 percent, well below its January 2007 high of $172.69. The cost of protecting against a default in Bear's outstanding debt was seven times higher than it had been at the beginning of 2007. Molinaro's comments moved the Dow Jones Industrial Average down 281.42 points, to 13,181.91. The stock of Lehman Brothers, which most people considered just a bigger version of Bear Stearns in terms of its fixed-income focus, fell 8 percent that day, to $55.78. “They called it the worst fixed-income markets in twenty years, grouping it with 1987 and the bursting of the Internet bubble,” Mayo later told the
Journal,
“and said they needed a better August just to get to the lower end of their historical range of returns.”

The next day, Saturday, the
Journal
reported on the extraordinary conference call, focusing on Upton's efforts to raise cash and to cut the firm's reliance on short-term debt. But the paper also reported—in the second paragraph—that the “firm plans to oust Warren Spector” and the board of directors was going to meet Monday to “discuss Mr. Spector's departure.” That same day, Roddy Boyd, then at the
New York Post,
reported that Spector had already been fired “as a direct result of his handling” of the collapse of the two hedge funds. “Warren never got out in front on this,” a source told Boyd. “In fact, it got worse on a daily basis and eventually put the firm at risk.”

I
T TURNED OUT
to be a busy weekend at 383 Madison. First, Bear's increasingly bloated and illiquid balance sheet—$525 billion of assets on a $12 billion sliver of equity, a leverage ratio of nearly forty-four times— had caught the attention of the SEC, which was coming to meet with the firm on Sunday to talk about how to get the leverage down, fast. The problem was Bear had no way to convey easily to the SEC what the firm's assets looked like and how its funding was structured. On Saturday, while Cayne shot an 88—one of his better scores—at the Hollywood Golf Club, Friedman called the entire repo desk into the office to pull together a report he could use with the SEC the next day. “The whole desk came in,” he said, “and spent the whole day—which shows you how fucked up our systems are—creating a funding report.” The report showed the firm's assets by asset type, what its day-to-day funding looked like, and how that funding was rolling off in the coming months. “The
picture was okay,” Friedman said, “but you could see stress, and I thought the SEC was going to just jump all over us.” Friedman met with the SEC at one o'clock Sunday and managed to assuage its concerns.

The other fire drill that weekend—organized by Steve Begleiter, the firm's head of strategy—was to “open the kimono” to KKR, the private equity firm whose founding partners had all worked at Bear Stearns a generation earlier. Begleiter had arranged for Deryck Maughan, the former CEO of Salomon Brothers who'd joined KKR in 2005 as chairman of KKR Asia, and his team of twenty to begin a preliminary review of Bear Stearns with the idea of making a large investment in the firm. The KKR meetings were Sunday morning, at the same time the Bear board of directors was meeting to decide Spector's fate. Both Cayne and Schwartz stopped by to say hello to Maughan. The idea was for KKR to inject several billion dollars into Bear in exchange for a 20 percent stake. “They were going to put a Good Housekeeping stamp of approval on us,” Friedman said. “That was the theory. We spent all day Sunday with them.” Various teams from Bear Stearns met seriatim with KKR to discuss the firm's funding, its mortgage positions, and its fixed-income business. “They had twenty guys prepared to spend as long as it took,” Friedman said, “so that inside a week they could get to a point where they could say yes or no. It wasn't urgent.”