House of Cards (79 page)

On the afternoon of August 5, Bear Stearns's thirteen-member board of directors ratified Spector's demotion to a simple senior managing director at the firm until such time as the firm and he reached agreement on his departure. The firm announced that Spector had “resigned” his other positions at the firm, effective immediately. Bear announced that Schwartz would become the sole president of the firm, that Molinaro would add the title of chief operating officer to that of chief financial officer, and that Jeffrey Mayer, co-head of fixed income, would replace Spector on the executive committee. Schwartz tried to convince Spector to stay on in some capacity, as a consultant of sorts to the firm. Schwartz even asked Jeff Mayer to intercede with Spector if he could. But Spector would not even consider the request. “On the one hand, he was a great guy to sacrifice,” one of Spector's colleagues said. “On the other hand, he was a terrible guy to lose.”

Monday was a day for spin and damage control. First, S&P released a statement suggesting that the markets might have overreacted. “Sprinzen, the weasel dick, publicly acknowledged that the market way overreacted, and that Bear Stearns fundamentally is sound, and the stock traded back up to $113,” Upton said. “It was a complete overreaction in the marketplace. But that was indicative of how sensitive equity investors
and, even more so, creditors were in that time frame.” Cayne called other Wall Street chieftains, such as Chuck Prince, at Citigroup, and Stan O'Neal, at Merrill Lynch, to reassure them about the firm's financial health and to find out whether there was any truth to the rumor that Wall Street CEOs were meeting together to talk about Bear Stearns. (Apparently there wasn't.) He took calls from counterparties and reassured them as well. He called the firm's institutional investors reeling from the losses in the firm's stock.

Cayne also spent two hours off-air with CNBC's Charlie Gasparino, to whom he also squelched a rumor that the Federal Reserve had called Bear Stearns to “help it deal with a pending liquidity crisis.” He said the purpose of the Friday conference call had been to try to put an end to the rumors. As for why he fired Spector, Cayne told Gasparino he had “lost confidence” in him after the collapse of the hedge funds. He also said an investigation at the hedge funds by Davis Polk partner Robert Fiske Jr. had turned up “preliminary problems of risk control,” and since the funds were Spector's responsibility, the “ax fell on him.” (In a brief interview, Fiske said he completed his investigation and made an oral report to the Bear Stearns audit committee about the hedge funds but that its contents were privileged.)

As for those who hoped that Spector's firing would lead to his own decision to step down as CEO by the end of the year, Cayne said: “Tell the people who say I'm going that in 2018 I'll be calling it a day.” He also reiterated his desire to keep the firm “independent.”

Some research analysts weren't buying the spin. “Jimmy Cayne's credibility is weak,” Richard Bove, at Punk Ziegel, said. “To have to boast about their liquidity is a sign of terrible weakness and doesn't jibe with the record earnings they've been reporting quarter after quarter. He can't go from earning $35 million and saying he's aware of everything going on in his company and then suddenly saying, ‘It's all Warren's fault' when something like this pops up.” He said Cayne should resign and investors should sell their Bear Stearns stock because no one could tell what was going on at the firm. David Weidner, at Market Watch, viewed Spector's firing as the typical act of an aging Wall Street CEO feeling his own mortality. “Ultimately, Spector may have the last laugh,” he wrote. “Cast into the wilderness, away from the place he had called home for 24 years, Spector is young enough to return to the industry in a better place. He has studied at the right hand of one of the toughest leaders on the Street. The odds are not against him. Meanwhile, Bear, Cayne and his new heir apparent, Alan Schwartz, have a wounded reputation to mend. And Schwartz might want to work on his resume.”

On Monday morning, Alan Schwartz, now Cayne's sole heir apparent, told the fifty top executives of the firm, who had assembled in the twelfth-floor dining room, “These are the types of markets in which Bear Stearns excels.”

The assembled group, including Cayne, gave Schwartz a standing ovation. Many in the audience saw the moment as an unofficial passing of the torch to Schwartz, who, if named CEO, would be the first investment banker in the firm's history to take the top job. John Rosenwald, a longtime investment banker at the firm and a vice chairman, was ecstatic. “I don't like him, I love him,” Rosenwald told the
New York Times
.

In its coverage of the August 3 conference call and the weekend firing of Spector, the
Wall Street Journal
mentioned that Wall Street was “buzzing with speculation” that Bear Stearns might seek a strategic investor to bolster its relatively small capital base. The paper made no mention of KKR's visit to 383 Madison but did suggest that the firm might seek an investment from China Citic Group, China's largest and most powerful investment bank. The paper mentioned Bear's discussion the previous year with China Construction Bank about buying a stake in Bear, although the talks apparently fizzled because the president of the Chinese bank left in the middle of the discussions. Supposedly, Donald Tang, a Bear Stearns vice chairman and native of China, was leading the efforts with China Citic.

On August 8, within a few days of Cayne's efforts to reassure the markets that the firm's capital base and liquidity were more than adequate, CNBC reported that Cayne was in the process of arranging for a trip to China to “seek a partnership and possibly a much-needed capital infusion from a Chinese firm.”

It had turned out that the Chinese executive with whom Cayne had been discussing a deal at China Construction Bank the year before, Chang Zhenming, had been transferred by the Chinese government back to Citic, where he had worked previously, as a top executive. Cayne had also played bridge with Chang back in 1993 in the Great Hall during his first visit to China. Why not rekindle the discussion, Cayne thought.

O
N
A
UGUST 9
, evidence of the international spread of America's sub-prime crisis showed up in Paris when BNP Paribas, France's largest bank, ceased withdrawals from three investment funds, which had about $2 billion in assets on August 7, because the bank could no longer “fairly” value them due to a “complete evaporation of liquidity in certain market segments of the U.S. securitization market.” BNP's action followed an
August 3 announcement by Union Investment Management, Germany's third-largest mutual fund manager, that it had stopped permitting withdrawals from one of its funds after investors pulled out 10 percent of the fund's assets. Also on August 9, the European Central Bank injected 95 billion Euros into the overnight lending market “in an unprecedented response to a sudden demand for cash from banks roiled by the subprime crisis,” Bloomberg reported.

Upton believed the events of August 9 were a watershed. “All of a sudden, interbank markets and general liquidity conditions seized up, and that condition persisted off and on, in varying degrees of intensity, from August ninth right through the time that the Fed opened the window to the investment banks, which happened to correspond to on or around the day that we went kaput,” he said. “I don't think that was pure coincidence, frankly. The decision was made that someone's got to experience some pain. This firm's had some scrapes with the regulators. No one really loves it that much.”

On August 17, the Federal Reserve began to take its first steps to try to stanch the bleeding. The central bank cut interest rates by 50 basis points in recognition that “financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward.” The Fed pledged to “act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.” The Fed also announced that banks could borrow from the discount window “for as long as 30 days, renewable by the borrower,” in order for banks to have “greater assurance about the cost and availability of funding.” The new plan would remain in effect “until the Federal Reserve determines that market liquidity has improved materially.” The two-pronged approach of lowering interest rates and effectively substituting the Fed's balance sheet for the balance sheets of the country's financial institutions, whether troubled or not, arose from a Fed off-site in Jackson Hole, Wyoming, during the third week of August 2007. New York Fed president Geithner dubbed this new approach to the growing crisis “the Bernanke doctrine.”

W
HILE
C
AYNE WAS
preparing for his trip to China and KKR was still contemplating an investment in Bear Stearns (the buyout firm shortly thereafter decided to pass), other investors were lining up to take a look at whether it made sense to put money into the firm. “I was hoping we would try to do something with them,” one Bear executive said of KKR. “We sort of backed off and they backed off. Jimmy thought it would look weak. He doesn't like to do things that look weak, and when he gets it in
his mind that something is weak, that's something we don't do. I thought that was unfortunate because I thought that would have helped … once KKR is in, they can't not stay in.” In mid-August, Christopher Flowers, of the eponymous private equity firm, came to 383 Madison to kick the tires about an investment in the firm for himself and, he claimed, for AIG. He met with Molinaro, Begleiter, and Friedman. But Flowers did not seem at all serious about the investment.

The firm also spent time with the Saudis' sovereign wealth fund. “We went very far down the path with the Saudis,” Paul Friedman said. “We thought that they were going to make us a $10 billion loan and take a 20 percent equity stake.” But that did not happen, either. Then there were the discussions with PIMCO, where several Bear Stearns alumni worked. “PIMCO was going to make around a $10 billion investment and was going to take out some equity,” Friedman said. “PIMCO had a huge exposure to Bear as it was. Their funds were big buyers of our debt. On the asset management side, they were a big counterparty to us, so they had a lot of counterparty exposure. They had a lot of friends here, so they were an early call. I don't know how far that ever went. There was a lot of speculation in the press that that was really close to happening. I don't think so. I don't quite understand how PIMCO structurally would have done it.”

In late August, the financial condition of the firm was continuing to deteriorate because the firm was unable to sell any of its illiquid assets and no counterparties were willing to write the firm any repos for terms longer than overnight. “All our funding is getting shorter and shorter,” Friedman said, “and the rock of illiquid assets stays pretty much intact.” Somehow, at the end of August, the firm was able to raise $2.5 billion in the institutional debt market. “We did a big victory lap for what we thought at the time was the worst deal in the history in the world,” Friedman said. At the same time, there were so many discussions with third parties about making an investment in the firm that Friedman and Begleiter used to joke about it. Said Friedman: “I actually had a regular conversation with Steve Begleiter, which started with ‘Have we sold the firm yet?' and I think the following day I went and grabbed him again and I said, ‘Now can we sell the firm? Somebody please sell this fucking firm!’”

One of the many strategic discussions involved a potential merger with Fortress Investment Group, run by Wes Edens. Fortress, part hedge fund and part private equity fund, completed its IPO in February 2007. By September, the firm's market capitalization was around $8 billion, making it about half Bear's size. Tom Flexner, the Bear vice chairman, brought Edens in to meet Cayne. “Jimmy was loving the idea because, first of all,
our asset management business had blown up with the hedge funds. Fortress had $38 billion of alternatives under management,” Flexner said. “They bring a principal mentality, which I think Jimmy was beginning to realize you need for your core business, too, for your balance sheet. He was loving it. But he was definitely afraid of how Alan would view it. I disagreed with him. But from Jimmy's standpoint, it was, ‘Well, if we do this, Wes isn't going to want to just run a little division. He's going to want to be CEO or something, and Alan would go crazy.’”