House of Cards (9 page)

While Schwartz was flying back to New York from Palm Beach on Wednesday afternoon after the end of the media conference, Molinaro and Upton, respectively Bear's CFO and treasurer, were meeting for several
hours with representatives of Moody's, the credit rating agency, to give them an update on the firm's prospects. “We're talking about our commercial mortgage book,” Upton said, “what it looks like for the quarter, what we think the P&L's going to be, and the status of funding and liquidity. Nothing formally prepared, just brief discussions around equity repo, fixed-income repo, commercial paper, bank funding, some of the things that were still hanging in.”

Rumors were now rife about how other Wall Street firms' clients had asked them to act as a counterparty to Bear, taking the clients out of the transaction, and that some of these competitors had refused to face off against Bear Stearns for their clients. Then there was that same persistent rumor about Goldman Sachs telling its hedge fund clients it would not act as counterparty to Bear. Some traders of credit default swaps and other derivative securities at Deutsche Bank were charging higher prices when Bear was the counterparty and were also charging bigger fees to their hedge fund clients who wanted the bank to take their positions as a counterparty to Bear. Margin calls to the firm were also increasing. On Wednesday afternoon, Bear's repo desk had already heard that $20 billion of the daily $75 billion needed to finance the business was not going to be there for it on Thursday morning. “By Wednesday, the cushion was basically gone,” Friedman said. “We were back to ‘Hope is our strategy. Let's hope it doesn't get any worse.’” Friedman began talking with Upton about using some of Bear's $18 billion in cash to make up for the lack of funding in the repo market. “How much money can you lend us if we need it?” Friedman asked Upton that afternoon. “Because Alan's speech didn't help. The Wednesday afternoon list for Thursday was really horrible.”

Bear Stearns then found that it could not replace an untapped $4 billion credit facility with a group of banks that was set to expire in April; it turned out the line had actually expired in February and had been replaced by one for $2.8 billion. Bear was waiting until the release of its quarterly earnings on March 20 to make this information public. “It was a line that we never really believed could ever be used,” Friedman said. “The joke was that it was appropriately named a ‘revolver,' because the only way it would ever get used is if you'd take it and put it as a gun to the heads of the banks and say, ‘Listen, lend me more on a secured basis, or I'm drawing down this $4 billion on an unsecured basis.' The theory was—there were so many theories that seemed good at the time—the theory was if you could give them enough collateral, the banks would lend you almost unlimited amounts of money to keep you from drawing down the revolver.” Bear had been paying fees on the revolver for ten years without ever using it. The idea was to restructure it to make it more
likely it could be used if needed. “We were going to structure it that we were going to draw it down from time to time,” Friedman continued, “and not have the signaling risk we were always afraid of, that everybody knows if you draw down your revolver you're dead. So yeah, the revolver was going to be smaller. It didn't seem like a big deal.”

Five minutes after Molinaro and Upton's meeting with Moody's ended, Molinaro called Upton and told him to “get Paul” and together come and see him immediately in his office. “I talked to Paul Friedman,” Upton said, “and Friedman said, ‘It's a fucking bloodbath at the repo desk. Everyone's calling and stepping away' It felt like more free credit money had gone out that day, too.” They decided there needed to be an all-hands-on-deck meeting around 5:15 that afternoon, including Schwartz, who had just returned from Palm Beach. “We went through what the cash flow was,” Upton said. “What had happened was we had gone from $18 billion-ish down to where we were at that time, to substantially south of $18 billion.” Upton pulled out a sheet of paper that had a list of about $15 billion worth of securities that Bear Stearns owned on its balance sheet that could be sold relatively quickly to generate some much-needed cash. For the previous nine months he had been unsuccessfully “pounding the table” that the firm should sell these assets, shrink the balance sheet, and generate cash. “Okay, the mortgages weren't going to be liquid, fine,” he recalled saying about his list. “But let's sell the assets that were liquid and start raising cash and shrinking our balance sheet and putting ourselves in a more fortress-like position to weather the coming storm. There was a whole list of $15 billion worth of assets that we had put together at different times over the course of the previous three quarters that we thought we could sell. We thought we should sell some mortgages, do what we can to sell some. Don't just hold on to them and try to hedge them and hope that they come back. Just sell them and take your losses and live to play another day.”

After Friedman finished with the crushing report on the repo financing, Upton followed with one about the cash fleeing from the prime brokerage accounts and about how tenuous the overall cash position of the firm was. Then he suggested selling assets, fast. After some debate, Upton recalled, “finally Schwartz, who now has the big testicles, says, ‘Well, I don't think we can do that. It's signaling risk. We can't signal the market, we can't just start selling assets wholesale, it's too much signaling.' Signaling was not an issue, should not have been an issue. Anyone who wasn't aware that there was the possibility that we had a problem was living in a cave and wasn't lending us money anyway.”

Although Upton was overruled on the idea of selling assets to raise
cash, the group did agree that afternoon to resolve Bear's disputes with its repo dealers over putting up more margin by agreeing to send them $1.5 billion in cash. “But the more pressing issues,” Upton said, “about selling assets, raising cash, raising liquidity, and any other constructive action we could take, was indicative of the previous nine months' paralysis. We got nothing…. I mean, everybody would have their own little fucking reason that was very silo-centric but didn't look at the good of the bigger firm.”

By Wednesday night, the Bear executives were increasingly concerned about their predicament. “During the course of that day,” the firm later admitted in an SEC filing in May 2008, “… an increased volume of customers expressed a desire to withdraw funds from, and certain counterparties expressed increased concern regarding their ordinary course exposure to, Bear Stearns, causing senior management of Bear Stearns to become concerned that if these circumstances accelerated Bear Stearns' liquidity could be negatively affected.” In other words, all the rumors were true. Now, on Wednesday night, the firm's management was worried about what effect they could have on the firm's business. As the repo desk confirmed through the course of Wednesday afternoon that the funding the next morning would be light, calls started going out to both the SEC and the New York Federal Reserve Bank to give them a sense of the deteriorating situation. Recalled Friedman: “The message was, ‘We're still alive. We're getting a little close to the edge, but we're still okay' I didn't think so, but that was the speech we gave the SEC, that was the speech we gave the Fed…. I thought it was already pretty much over.” Repo money was disappearing and customers were sending their equity positions elsewhere, “which created some funding problems because you had longs and shorts of customers. Firm positions funded each other and you have pieces going away, and we're running out of cash.”

In late 2007, Bear Stearns had hired Gary Parr, the highly regarded Lazard financial institutions banker, to help the firm explore potential joint ventures or other strategic combinations. Parr had had a small role in helping Bear Stearns's management evaluate the possible merger of Bear with Fortress Investment Group, a ten-year-old Manhattan-based hedge fund and private equity management company with $34 billion in assets. Wesley Edens, Fortress's CEO, was close to many Bear executives. The potential merger, which would have given Bear's shareholders two-thirds of the combined company's ownership, had been discussed in earnest from September to December 2007. Ultimately, Schwartz vetoed the deal after he became CEO in January 2008. Nothing came of the Fortress idea or any of Parr's other efforts, although not from a lack of trying.

After the hair-raising discussion about the firm's cash position in Molinaro's conference room late Wednesday afternoon, Schwartz and Molinaro discussed the firm's predicament with Parr and H. Rodgin “Rog” Cohen, the senior partner of the Wall Street law firm Sullivan & Cromwell and an expert in deals involving financial firms. Cohen was at his home in Irvington, New York, on the Hudson River north of Manhattan. Parr had been in Brooklyn watching Patrick Stewart in
Macbeth
at the Brooklyn Academy of Music—he has a passion for Shakespeare—but he hailed a cab for Manhattan at the play's intermission. Schwartz told his advisors he was concerned that hedge funds would continue to withdraw their money from the firm. They batted around different ideas about what could be done to help Bear Stearns, including considering whether private equity firms or commercial banks might be able to put together a solution quickly. But soon enough they concluded there was just one answer. “The only people who can do anything about this are the Fed,” Cohen recalled saying to Schwartz and Molinaro. “So that's when I did call Tim Geithner about it very late at night.” Cohen urged the president of the New York Federal Reserve Bank to speed up the timing of the loan program announced the day before, rather than waiting until March 27. He also urged the Fed president to consider opening the so-called Fed discount window so that the Fed could lend money to investment banks directly, as it did already for commercial banks, which of course are more closely regulated as a result. “I think I've been around long enough to sense a very serious problem, and this seems like one,” Cohen told him. Geithner's response was, “If it's this serious, Alan should pick up the phone and call me first thing in the morning.”

As instructed, Schwartz called Geithner the next morning. Schwartz was focused and calm, but also very worried about the firm's future. The
Wall Street Journal
had reported that morning that Bear's counterparties were increasingly cautious about dealing with the firm. The two men talked through Bear's options and specifically who could be found quickly to either finance the firm with longer-term capital or buy it outright. On Schwartz's behalf, Parr began making calls Thursday morning to see if he could determine who might be interested and able to help Bear Stearns grapple with its emergency. Among those Parr contacted on Thursday morning were JPMorgan and Barclays. Barclays did not really show much interest; JPMorgan's reaction was that they'd think about it, but they didn't really engage over the course of the day, either.

Ironically, on the same morning as the crisis inside Bear Stearns was intensifying, Henry M. Paulson Jr., the U.S. Treasury secretary and the former CEO of Goldman Sachs, issued the findings of the President's
Working Group on Financial Markets on the “developing financial market turmoil,” as Paulson called it. As the depth of the credit crisis began revealing itself during the previous summer, President George W. Bush had asked Paulson and the working group to review the underlying causes of the problem and to recommend remedies. In many ways, the report echoed many of the points Geithner made in his March 6 speech at the Council on Foreign Relations. “Our objectives—which we believe these recommendations will achieve—are improved transparency and disclosure, better risk awareness and management, and stronger oversight,” Paulson wrote in his cover letter to Bush. “Collectively, these recommendations will mitigate systemic risk, help restore investor confidence, and facilitate economic growth.” He also added presciently, “Obviously, market turmoil is still playing out, and all market participants and policy makers are deeply engaged in addressing the current situation. We must implement these recommendations with an eye toward not creating a burden that exacerbates today's market stresses.”

At the start of the day on March 13, Bear Stearns had about $18 billion of unencumbered cash—“liquidity resources,” as another Bear insider described it—on its balance sheet, roughly the same amount that it had had at the end of its first quarter of the fiscal year. Bear's repo desk was worried about whether its traditional group of overnight lenders would show up, and Schwartz hoped that $18 billion would be enough of a cushion should the firm's hedge fund clients continue their demands to get their cash out of the firm.

Like the skilled mergers-and-acquisitions (M&A) banker he was, Schwartz was careful not to let most of the Bear Stearns executives know how concerned he had become. Only a very few were aware that Cohen had called Geithner the night before or that Schwartz had called Geithner that morning. This came as a shock to even the firm's most senior executives when they learned of it, especially since in public Schwartz was making every effort to play down his concerns and reassure the troops. At noon on Thursday, Schwartz presided over a lunch of grilled chicken and sandwiches for the firm's President's Advisory Council (PAC), a group of Bear's top fifty or so professionals. (The group kept growing in size because, in typical Bear fashion, people would be added over time but nobody would be told they were no longer important enough to be part of it.) “At that lunch, Alan said everything was fine,” recalled one PAC member who was there. “Is he going to lie to us and say that he couldn't conceive of a scenario where it wouldn't be fine? No. But you know, he wanted us to get back to our business with our clients.”

Another senior managing director at the PAC lunch had received
an e-mail from a colleague in Saudi Arabia that morning with the news that the Saudis were willing to invest immediately in Bear Stearns. The gist of the e-mail was, “They want to give us a significant amount. We can set it up. They want to do it now. They can act quickly.” The banker sent the message on to Schwartz but got no real response other than being told to speak to Steve Begleiter, the head of corporate strategy. Begleiter was understandably preoccupied and did little to advance the Saudi idea when it was presented that morning. “Then I decided to physically go up to Alan” at the PAC luncheon, the banker remembered, “and after the lunch, where he says, ‘Everything's fine. Don't worry' I said, Alan, I just want you to know, the Saudis want to give us money.' He said, ‘We don't need capital.’” The banker believed it would have been a good move to announce that afternoon that the Saudis were willing to put money into Bear. “But there was just this feeling of we didn't need to do it.”