House of Cards (86 page)

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ews of Cayne's departure leaked to the
Wall Street Journal
the next morning. On January 8, Kate Kelly reported that Cayne was “stepping down” after developing “a reputation for being a hands-off leader last year as the current credit crisis unfolded.” She reported that Cayne had started notifying directors of his decision and that Schwartz would succeed him as CEO. While the choice of Schwartz was a foregone conclusion, it also marked a radical departure for the heavily fixed-income-oriented firm to appoint an M&A banker to its helm at a time when the carnage in the mortgage side of the business was rising exponentially. In her article, Kelly quoted Meredith Whitney, the research analyst. “They have incurred so much franchise damage,” Whitney said, “that what investors are concerned about most is revenue replacement. How the firm did as well as it did, with such a hands-off manager, is really impressive.” There also seemed to be a consensus in the analyst community that it was a mistake for the board to keep Cayne as its chairman. “Jimmy Cayne should be out of the company,” Dick Bove said. “To leave him in there as chairman is, in my view, an outrage.” The day before, Bear's stock closed at $76.25, down 3.3 percent and nearly $100 per share below where it had been one year earlier.

The
Journal
story turned out to be the high point of Schwartz's day. He held a series of smaller meetings with the leaders of the firm's business units and got an earful in each one. He started by having breakfast with the heads of fixed income. There were about twenty-five people together in the twelfth-floor boardroom. “He took us through ‘Now that Jimmy is gone, we got a lot of things that we want to do. I'm going to be meeting with a lot of people. We really need to work together,’” Paul Friedman remembered. “He spoke really well, as he always does. He spoke for about twenty to thirty minutes, and when he got done, he was greeted by a fair amount of hostility. The opening five questions were all about, ‘What are we doing to raise capital?' He gave what became his standard speech: ‘There's three ways to raise capital. You don't want to raise it the wrong way. We have no immediate need to raise capital.' We're
all going, ‘How about now?' He's saying, ‘Well, we're not ruling it out but we're going to work on it in an orderly process.' People just pounded him again: ‘Everybody else has raised capital. Why aren't we?’” (By this time, Wall Street firms had raised in excess of $200 billion in capital; by June 2008 that figure would be more than $300 billion.)

The meeting broke up and the fixed-income leadership returned to the trading floor. “The view was, ‘That wasn't what I wanted to hear,’” Friedman said. “He then had a similar lunch meeting with the equity guys, and I'm told it was somewhat of a similar tone, although they have fewer rude people than we do, apparently, so they were less in his face, but he got a similar response.”

Despite the exhortations, Schwartz seemed determined not to raise new capital at the firm just for the sake of raising new capital. If there were a strategic purpose, he might consider it, but just getting cash in the door was of little interest to him. He quickly set about scuttling some of the remaining potential opportunities still being bandied about the firm. One of Schwartz's first strategic decisions was to put the final nail in the coffin of the merger with Fortress for any number of reasons. As for selling the company, he said early on and publicly, “Being acquired is not a strategy…. We have tremendous opportunites for growth, as much as I've ever seen.” On January 9, in an eighteen-minute television interview with CNBC's David Faber, Schwartz reiterated his view that the firm was adequately capitalized and was unlikely to be part of a merger or acquisition anytime soon. “The strategy has to be to grow our business profitably,” he said. “We need to earn a good return on equity. We need to grow our book value and need to do that in businesses we can grow organically.” Only after that would a deal make sense, he said.

Schwartz seemed pulled in many different directions right from the start. “I'm putting down my pen,” Wes Edens told Tom Flexner, the Bear vice chairman who'd introduced the Fortress merger idea. “Let's visit this in two or three months. Maybe the markets will be a little bit better. We're not doing this because it's two companies in distress. We're doing this because we think one plus one is going to equal three. Obviously, too much is going on.” Flexner was disappointed and blamed Schwartz. “We just really spent a huge amount of time on the deal,” he said. “At the end of the day, I actually think if we'd done that deal we'd be in business today. Alan Schwartz could not pull the trigger, and I thought that it would have made a difference to our prospects.”

The next opportunity came from Sumitomo Bank, one of the largest banks in Japan. Michel Péretié, the CEO of Bear Stearns in Europe and based in London, had repeatedly suggested to the New York leaders that
Sumitomo had an interest in doing “something structurally” with Bear Stearns, but the response in the late fall had been one of indifference, especially since so much time and effort was being put into making the Citic deal a reality. No one wanted to stop and try to figure out if the Citic deal would work alongside something Sumitomo might be contemplating. On January 10, at a meeting of the management and compensation committees, Péretié tried again. This time he had a proposal in hand from the Japanese. The idea was for Sumitomo to buy a stake in Bear Stearns of between 9.9 percent and 30 percent—the stock was then trading around $70 per share—and to use its sales force to help sell some of Bear's warehouse of hard-to-sell assets. In particular, the Japanese thought they could sell pieces of Bear Stearns's $5 billion slug of leftover debt from Blackstone's LBO of Hilton Hotels. “This is January and things are getting pretty edgy,” Friedman said. “To the outside world things may have seemed okay. But when your stock is at $170 per share, $100 looks pretty dicey. To those of us on the inside going, ‘We can't sell anything. We can't raise any new money. What's our plan?' it seemed like a pretty good thing.”

At the committee meeting, the Sumitomo proposal “gets a partial hearing,” Friedman said. “But the issue that we kept getting hung up with is we've got this unformed, semicoherent joint venture pending with Citic. Now, you've got this trillion-dollar bank, one of the largest and most financially solvent banks in the world, that wants to get involved with us. How would you even structure this third-party joint venture with this unformed other joint venture? Could you even do it? We made this big thing about Citic. We've put all these resources into it. There was a lot of press. This would be a loss of face.” The collective wisdom at the meeting was that the Sumitomo deal was just too complicated. They decided to keep the Sumitomo fish on the line, though, just in case the Citic deal fell apart, which was still a distinct possibility because of the Chinese bureaucracy and increasing nervousness about Bear's near-term performance.

Next up was perhaps the wackiest idea of them all: a merger with Residential Capital, known as ResCap, the residential mortgage business of GMAC, both of which were owned by Cerberus, the private equity firm. “This one was truly insane,” Friedman said. Dubbed “Project Reno,” the idea—led by Schwartz and his colleagues Richie Metrick and Mike Offitt—was to somehow merge a cleaned-up ResCap into Bear Stearns's mortgage business, in effect tripling down on the firm's residential mortgage business at precisely the wrong moment based on a belief that there would be a financial opportunity coming in distressed mortgages. There
was a huge meeting on the forty-third floor of 383 Madison to begin the process of looking at this deal. “Anybody who can spell ‘mortgage' and anybody who's even remotely involved in any aspect of the mortgage business gets invited to this thing,” Friedman said. To make the failing business more palatable to Bear Stearns, Cerberus first planned to restructure the company's balance sheet by “cramming down” the existing debt holders, forcing them to take equity in the business (and presumably wiping out Cerberus's equity). Additionally, Cerberus would fire five thousand employees, get rid of the mortgage origination business—who needed one of those anymore, anyway?—and then Bear Stearns would issue stock to the new equity holders of ResCap for the mortgage servicing business that remained. “My initial thought was, ‘So on that day, if we ever actually could do this, we would get downgraded to a single-B on the spot,’” Friedman said. “I actually asked that question and was told, ‘Just hold all those thoughts until later. We've got to work out our due diligence first.’”

Teams of Bear Stearns bankers and traders spent hundreds of hours exploring this deal—which would have raised no new capital for the firm—in due diligence meetings in Minnesota and Pennsylvania. “You had twenty people from the mortgage department and all the senior people involved in this,” Friedman said. “Our treasurer's department, the accounting department, the tax department, operations accounting, technology—everybody was involved. All the best and brightest, maybe fifty to a hundred people, including Steve Begleiter from our corporate strategies group—all focused now on ResCap due diligence. We've got people flying all around the country working on this trade that was just insanity. Even if it could be done, it made no sense. Our servicing portfolio at EMC Mortgage was going to go up by 500 percent. The integration concept was crazy—of taking their technology and our technology, their operations, their people, and they owned a bank, GMAC bank, that was somehow going to be folded into our crappy little bank. Nuts. It was going to take every legal and regulatory mind we had to figure out how to do that and get the OCC, the FDIC, and the SEC and all the other C's to approve it. Insane. Weeks and weeks of work go into this. Then it just sort of stopped.”

The ResCap and Sumitomo opportunities were the last two to come Bear's way until the end, in March, when the deal dynamics for the firm were very different. “As the stock price gets lower and lower,” Friedman said, “it becomes less and less possible to do anything because somebody putting in a couple billion dollars now owns 40 percent of the company. That wasn't going to happen. What's the old line: ‘Hope is not a strategy'?
Well, hope was our strategy. That was basically where we were: ‘Let's just see if we can sell some things. See if things will come down. Let's get through the quarter.' Everybody was focused on ‘Let's get through the first quarter with good earnings and then see if we can get the Sumitomo trade approved. If we get good earnings, the pressure will come off. Life will go on. We can go back to business. Markets will see that we, and hopefully everybody else, will do okay, and things will get better.' Since it was kind of the only thought we had and the only plan, and since it was a good quarter, it all seemed like that made sense. Even through February.”

With Spector long gone, both Cayne and Schwartz—neither of whom really knew very much about fixed income or exotic securities or how to make them or sell them—started spending more and more time on the seventh floor of 383 Madison trying to pick up the gist of what went on there. Cayne's visits were superficial and the source of great amusement to the traders. “It was clear when Warren left, Jimmy had no idea what we did for a living in fixed income,” Friedman said. “Unlike Alan, who didn't get it and knew he didn't get it and tried, Jimmy had no clue. He would now come up to the fixed-income floor and wander around and try to find some common ground: ‘How you doing?' or ‘What's going on?' He'd have heard of some customer name—Thornburg, for example, was falling apart at that point—and he'd go, ‘How's Thornburg going?' It's like, ‘Fine. Nothing changed since yesterday.' He couldn't find a point of intersection. There was no way he could learn it unless he experienced it. It was sort of hopeless.”

Schwartz's visits were far more regular and more substantive. He started taking up residence in Spector's office on the seventh floor two mornings a week, while maintaining his office on the forty-second floor. After all, he knew he was not Lloyd Blankfein—the CEO of Goldman Sachs and a former commodities salesman—and he was determined to get his arms around the problem if he could. “But it was like Bonds 101,” Friedman said. “You're starting with, ‘Prices go up, yields go down. And how do you calculate duration?' And I say that not to denigrate Alan. It's not what he did for a living, and he picked up on it faster than most humans could. But he never really got it. It wasn't what he did. It would take you fifteen years to get up to speed on the funky shit that we owned.”