From left: former Bear Stearns C.E.O.’s Alan Schwartz, James Cayne, and Alan “Ace” Greenberg, in front of the firm’s former headquarters, in New York City.
Bringing Down Bear Stearns
On Monday, March 10, the rumor started: Bear Stearns was having liquidity problems. In fact, the maverick investment bank had around $18 billion in cash reserves. But soon the speculation created its own reality, and the race was on to keep Bear’s crisis from ravaging Wall Street. With the blow-by-blow from insiders, Bryan Burrough follows the players—Bear’s stunned executives, trigger-happy reporters at CNBC, a nervous Fed, a shadowy group of short-sellers—in what some believe was the greatest financial scandal in history.
by Bryan Burrough August 2008
On Monday, March 10, Wall Street was tense, as it had been for months. The mortgage market had crashed; major companies like Citigroup and Merrill Lynch had written off billions of dollars in bad loans. In what the economists called a “credit crisis,” the big banks were so spooked they had all but stopped lending money, a trend which, if it continued, would spell disaster on 21st-century Wall Street, where trading firms routinely borrow as much as 50 times the cash in their accounts to trade complex financial instruments such as derivatives.
Still, as he drove in from his Connecticut home to the glass-sheathed Midtown Manhattan headquarters of Bear Stearns, Sam Molinaro wasn’t expecting trouble. Molinaro, 50, Bear’s popular chief financial officer, thought he could spot the first rays of daylight at the end of nine solid months of nonstop crisis. The nation’s fifth-largest investment bank, known for its notoriously freewheeling—some would say maverick—culture, Bear had pledged to fork over more than $3 billion the previous summer to bail out one of its two hedge funds that had bet heavily on subprime loans. At the time, rumors flew it would go bankrupt. Bear’s swashbuckling C.E.O., 74-year-old Jimmy Cayne, pilloried as a detached figure who played bridge and rounds of golf while his firm was in crisis, had been ousted in January. His replacement, an easygoing 58-year-old investment banker named Alan Schwartz, was down at the Breakers resort in Palm Beach that morning, rubbing elbows with News Corp.’s Rupert Murdoch and Viacom’s Sumner Redstone at Bear’s annual media conference.
It was an uneventful morning—at first. Molinaro sat in his sixth-floor corner office, overlooking Madison Avenue, catching up on paperwork after a week-long trip visiting European investors. Then, around 11, something happened. Exactly what, no one knows to this day. But Bear’s stock began to fall. It was then, questioning his trading desks downstairs, that Molinaro first heard the rumor: Bear was having liquidity troubles, Wall Street’s way of saying the firm was running out of money. Molinaro made a face. This was crazy. There was no liquidity problem. Bear had about $18 billion in cash reserves.
Yet the whiff of gossip Molinaro heard that morning was the first tiny ripple in what within hours would grow into a tidal wave of rumor and speculation that would crash down upon Bear Stearns and, in the span of one fateful week, destroy a firm that had thrived on Wall Street since its founding, in 1923.
The fall of Bear Stearns wasn’t just another financial collapse. There has never been anything on Wall Street to compare to it: a “run” on a major investment bank, caused in large part not by a criminal indictment or some mammoth quarterly loss but by rumor and innuendo that, as best one can tell, had little basis in fact. Bear had endured more than its share of self-inflicted wounds in the previous year, but there was no reason it had to die that week in March.
What happened? Was it death by natural causes, or was it, as some suspect, murder? More than a few veteran Wall Streeters believe an investigation by the Securities and Exchange Commission will uncover evidence that Bear was the victim of a gigantic “bear raid”—that is, a malicious attack brought by so-called short-sellers, the vultures of Wall Street, who make bets that a firm’s stock will go down. It’s a surprisingly difficult theory to prove, and nothing short of government subpoenas is likely to do it. Faced with a thicket of lawsuits and federal investigations, not a soul in Bear’s boardroom will speak for the record, but on background, a few are finally ready to name names.
“I don’t know of any firm, no matter the capital, that could have withstood that kind of bombardment by the shorts,” says a vice-chairman of another major investment bank. “This was not about capital. It was about people losing confidence, spurred on by rumors fueled by people who had an interest in the fall of Bear Stearns.”
He pauses to let the idea sink in. “If I had to pick the biggest financial crime ever perpetuated,” he concludes, “I would say, ‘Bear Stearns.’ ”
At Phi Kappa Wall Street, most of the frat boys are instantly recognizable. There’s the big, backslapping Irishman, Merrill Lynch, the humorless grind, Goldman Sachs, and the straitlaced rich kid, Morgan Stanley. And then, off in the corner, wearing its beat-up leather jacket and nursing a cigarette, was the tough-guy loner, scrawny Bear Stearns, who disdained secret handshakes and towel snapping in favor of an extended middle finger toward pretty much everyone. Bear was bridge-and-tunnel and proud of it. Since the days when the Goldmans and Morgans cared mostly about hiring young men from the best families and schools, “the Bear,” as old-timers still call it, cared about one thing and one thing only: making money. Brooklyn, Queens, or Poughkeepsie; City College, Hofstra, or Ohio State; Jew or Gentile—it didn’t matter where you came from; if you could make money on the trading floor, Bear Stearns was the place for you. Its longtime chairman Alan “Ace” Greenberg even coined a name for his motley hires: P.S.D.’s, for poor, smart, and a deep desire to get rich.
Bear Stearns was an investment bank, but the traditional banking roles, such as advising on corporate mergers and trading stocks, were always an afterthought there. What the P.S.D.’s at Bear Stearns did best was trade bonds. The firm’s executive history was the story of three bond traders, each with his own outsize personality. From the mid-1930s till the late 1970s, Bear was the province of Salim “Cy” Lewis, the cantankerous Wall Street legend who forged a cutthroat culture run less as a modern corporation than as a series of squabbling fiefdoms, each vying for his approval. Ace Greenberg, an avuncular sort who kept his desk on the trading floor and answered his own phone, took over after Lewis’s death, in 1978, and while his edges were softer, Bear remained a Mametesque pressure cooker where top traders could pull down $10 million a year while runners-up were tossed into the alley.
The third man, the one who oversaw Bear’s demise after nudging Greenberg aside in 1993, was his longtime protégé, Jimmy Cayne. Cayne was a cigar-chomping kid from Chicago’s South Side, who in his early years sold scrap metal for his father-in-law. After a divorce, he found himself driving a New York taxi while pursuing his beloved pastime, playing bridge. It was at a bridge table, in fact, that Greenberg, himself an ardent player, met Cayne and lured him to Bear Stearns. “If you can sell scrap metal,” Bear lore quotes Greenberg telling Cayne, “you can sell bonds.” Cayne found his life’s calling on the trading floor, earning his bones by moving huge numbers of New York municipal bonds during the city’s financial crisis of the 1970s. He became the embodiment of Bear Stearns, a go-it-alone maverick who hunkered down in his smoke-filled sixth-floor office, not giving a rat’s ass what Wall Street thought so long as Bear made money. When an early hedge fund, Long-Term Capital Management, collapsed in 1998, losing $4.6 billion and triggering fears of a global financial meltdown, Cayne famously refused to join the syndicate of Wall Street firms that bailed it out. Instead, while much of the Street reaped billions trading stocks during the booming 1990s, Cayne kept Bear focused on bonds and the grimier corners of Wall Street plumbing, clearing trades for just about anyone, however notorious their reputation.
Through it all, Bear remained proudly independent, refusing to sell out to larger firms. Cayne listened to lots of offers, especially after his pal Don Marron sold rival PaineWebber to U.B.S. for $12 billion, in 2000, but Cayne preferred life as it was. Senior managers had wide autonomy, and in good years Bear all but ran itself, allowing Cayne to spend weeks away from his desk at bridge tournaments or playing golf near his vacation home on the Jersey Shore. In recent years much of the oversight fell to Cayne’s two co-presidents, Alan Schwartz, a onetime pitcher at Duke University who specialized in media mergers, and another bridge aficionado, a talented trader named Warren Spector. Bear continued to thrive, piling up record profits all through the 2000s, and Bear’s stock price rose nearly 600 percent during Cayne’s 14 years as C.E.O.
Exclusive book excerpt: Bestselling author William Cohan uncovers the inner workings of the misadventure that brought down Bear Stearns and foreshadowed the financial crisis to come.
By William D. Cohan
Last Updated: March 4, 2009: 10:19 AM ET
NEW YORK (Fortune) -- Years from now, when academics search for causes of the stock market crash of 2008, they will focus on the pivotal role of mortgage-backed securities. These exotic financial instruments allowed a downturn in U.S. home prices to morph into a contagion that brought down Bear Stearns a year ago this month - and more recently have brought the global banking system to its knees.
What scholars should not miss is the role that the human element - call it greed or ignorance - played in this tragedy. In an exclusive excerpt from William Cohan's new book, "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street," to be published March 10 by Doubleday, the bestselling author sheds light on the bankers who thought they had mastered what Warren Buffett has called "financial weapons of mass destruction."
By looking back to the roots of the misadventure in which Bear Stearns traders Ralph Cioffi and Matthew Tannin lost roughly $1.6 billion while allegedly misleading investors, Cohan illustrates how the missteps of the few can have consequences for the many.
When the first jet hit the World Trade Center towers on the morning of September 11, 2001, Jimmy Cayne, then chairman and CEO of Bear Stearns, turned on a small television in his midtown Manhattan office and watched in disbelief as the second jet hit the south tower. Later in the day, Cayne got a call from Richard Grasso, then CEO of the New York Stock Exchange, telling him that it was important to the United States government that the exchange reopen as quickly as possible. To that end, Grasso said there would be a meeting the next morning at the stock exchange among the heads of all the Wall Street firms.
When Cayne woke up the next morning, he saw on the news that New York City had closed off access to lower Manhattan below 15th Street, including the New York Stock Exchange. Cayne called Grasso at home and offered to host the meeting instead at Bear Stearns. Grasso quickly agreed to Cayne's suggestion, and the meeting was held in the seventh-floor boardroom on Wednesday at two o'clock. "Everybody in the world was there," Cayne said. "Everybody. This was heavy cake. I've never seen all these people, the heads of every major firm, sit in a room and not hate each other."
Bear Stearns, the fifth-largest U.S. investment bank, survived the 9/11 attacks unscathed, just as it had survived unscathed every other major crisis since its founding in 1923, among them: the Great Depression, World War II and the 1987 market crash. Indeed, until the very end, the firm had never had a losing quarter in its history. But in the months following 9-11, Cayne and his senior management team, including Alan "Ace" Greenberg, Warren Spector and Alan Schwartz would unwittingly sow the seeds of the firm's destruction by betting heavily on the manufacture and the sale of mortgage-backed securities.
In the short run, the decision by Bear's executives to become a leader in this business resulted in huge profits for the firm - and massive paychecks for them. Along with bankers at Lehman Brothers, Merrill Lynch and Morgan Stanley (MS, Fortune 500), they were only too happy to capitalize on the mortgage boom that occurred in the wake of 9-11 when the Federal Reserve loosened the money supply.
One of Bear Stearns profit centers was a small hedge-fund division. The firm seeded it with a relatively trifling $45 million equity investment. Ralph Cioffi (pronounced Chee-off-ee), a longtime Bear Stearns fixed-income salesman turned hedge-fund manager, ran it. The funds were part of the firm's relatively tiny asset management business, known as BSAM. BSAM reported to Warren Spector, Bear's resident wunderkind, who as the firm's co-president (with Alan Schwartz) was responsible for overseeing 90% of its revenue, including its massive fixed-income business.
Like Cayne and Ace Greenberg, the boyish Spector was a world-class bridge player and many people both inside and outside Bear Stearns considered it inevitable that he would one day soon run the firm. In October 2003, Spector's friend Cioffi moved from Bear's fixed-income department to BSAM and set up a hedge fund, called the High-Grade Structured Credit Fund, with money from outside investors. The fund eventually would have around $1.5 billion of investors' cash in it. Then 47, Cioffi had joined Bear Stearns in 1985 as an institutional fixed-income salesman, specializing in structured finance products.
Cioffi grew up in South Burlington, Vermont, near Lake Champlain. From 1989 to 1991, he was the New York head of fixed-income sales and then, for the next three years, served as global product and sales manager for high-grade credit products. As a salesman, Cioffi covered the Ohio Public Employees Retirement System account and was making around $4 million, year after year. "He was the top fixed-income salesman in a firm where fixed income was king," said one senior managing director.
"We all grew up with Ralph here," explained Paul Friedman, who was the chief operating officer of Bear's fixed-income division. "Ralph is one of the smartest guys I've ever met and was absolutely the best salesman I've ever met. When I was a trader, he was a salesman, a fabulous salesman. He was incredibly personable, incredibly smart, creative and could get things done." As a manager, Cioffi was another story. "He had adult ADD," says Friedman.
Helping Cioffi run the hedge fund was Matthew Tannin, six years his junior. Tannin, born in New Jersey, was a graduate of the University of San Francisco law school. He joined Bear Stearns in 1994 and spent seven years structuring collateralized debt obligations. In 2001, he moved over to research, where he studied the trading and value of CDOs.
At the outset, Cioffi and Tannin (pronounced Ta-neen) told investors the High-Grade Structured Credit Fund would invest in low-risk, high-grade debt securities, such as tranches of CDOs, which the ratings agencies had rated either AAA or AA. The fund would focus on using leverage to generate returns by borrowing money in the low-cost, short-term repo markets to buy higher yielding, long-term CDOs.
The difference between the interest rate at which the fund could borrow money and the yield on the CDOs, enhanced by the use of borrowed money, would generage the fund's profits. In August 2006, Cioffi and Tannin decided to open a second fund, the Enhanced Fund, that used substantially more leverage - and took more risk - than the High-Grade Fund. The Enhanced Fund had about $600 million of investors' money in it and used a $400 million credit facility from Barclays, the large British bank, to leverage the securities Cioffi and Tannin bought.
For 40 months, Cioffi's High-Grade hedge fund never had a losing month. During that time, it achieved a 50% cumulative return. The Enhanced Fund also performed well during its short existence. In typical hedge fund fashion, BSAM kept 20% of the profits generated by the funds plus a 2% fee on the net assets under management; fees from the High-Grade Fund alone accounted for 75% of BSAM's total revenues in 2004 and 2005.
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