How Bear aided its own demise

By John Gapper

When the going gets tough, the tough get going. That is the cliché about surviving crises. It is not: When the going gets tough, the tough go to Detroit to play bridge.

But a bridge tournament in Detroit was where Jimmy Cayne, chairman of Bear Stearns, chose to be at the end of last week as his investment bank became embroiled in a solvency crisis. By the time he returned to New York to lend a hand in person, the rest of Wall Street had pulled the plug and the Federal Reserve had been forced to provide emergency funding to Bear through JPMorgan Chase.

Mr Cayne’s response to last week’s crisis, which culminated in JPMorgan taking over Bear for $2 a share and wiping out a lot of his wealth, was a fitting end to a year during which Bear executives tried insouciantly to shrug off the doubts of investors and other banks about their business. The end result was humiliation and ruin for Bear’s 14,000 employees.

It is tempting to think that Bear was simply a victim of circumstance. On that view, one of Wall Street’s biggest investment banks was unwittingly caught up in the worst financial turmoil for decades and suffered a flight by hedge funds and lenders in the bond repo market. It was a perfectly solvent business that was engulfed in the credit crisis like Northern Rock before it.

This was the conclusion drawn by Stephen Raphael, a former Bear board member. Speaking to The Wall Street Journal, which also disclosed Mr Cayne’s bridge jaunt, he said: “Wall Street is really predicated on greed. This could happen to any firm.”

Well, up to a point. The truth is that other Wall Street firms have managed to avoid Bear’s fate, so far at least. Lehman Brothers, whose shares fell sharply on Monday because it was seen as the next one in line, managed its balance sheet better and battled more effectively.

Before he stepped down as chief executive in January and handed the job to Alan Schwartz, Mr Cayne was lackadaisical about communicating with the outside world. He stepped out early from a call with investors in August to discuss the collapse of two of the bank’s hedge funds and did not even appear on others.

Mr Cayne, who is 74, was not the only bridge player. Warren Spector, whom he fired as co-president and head of securities at Bear in August, was at a bridge tournament in July as the two hedge funds were going under. Alan Greenberg, the 80-year-old chairman of its management committee and former chief executive, is also a bridge enthusiast.

Rampant card-playing was a symptom of a bigger disorder at Bear – the bank’s inward-looking and obstreperous culture. It grew up as a scrappy bond-trading firm that did not care about how others regarded it. That culminated in Mr Cayne’s (with hindsight ironic) decision in 1998 to shun the Fed-backed attempt to save the hedge fund Long-Term Capital Management from collapse.

Throughout the year-long rolling crisis that ended in disaster, its leaders took the stance that it would be OK as long as its employees kept the faith. They did too little to reassure outsiders and to let them know what was going on. Last week, Bear reacted to growing uncertainty by issuing a bland and detail-free statement that it had no problems with capital or liquidity.

Nor did Bear’s leaders do enough to strengthen its balance sheet and cut leverage while they had the chance. It tried to swap $1bn stakes with Citic, the Chinese broking firm, but it was stuck with a big slice of its assets in mortgage-backed securities, which were hard to shift, and it needed more capital and longer-term secured funding to ride out trouble.

JPMorgan’s low-ball bid means that Bear’s employees, who own about a third of its equity, have collectively lost billions. With their initial shock now turning to anger and bitterness – and a desperate hope that someone will emerge with a better offer – some now argue that Bear was treated unfairly by the Federal Reserve.

Investment banks are fragile institutions. They have high leverage, they are not retail deposit-taking institutions like commercial banks and they depend on sources of funding that are prone to dry up in times of crisis. Bear veered to the brink of collapse within days because it stopped being able to raise short-term finance by lending securities in the repo market.

In principle, any broker could find itself in a similar position to Bear. That was why the Fed offered to swap up to $200bn of mortgage securities for Treasuries last week and then took the historic step on Sunday of offering to lend to investment banks through its discount window. It did not want Bear’s fate to befall others, notably Lehman Brothers.

So Lehman got more support than Bear. But you make your own luck and Lehman had already taken firmer action to bolster its balance sheet – its cash cushion was double the size of Bear’s. It also mounted a tough and disciplined campaign to reassure the waverers; on its Tuesday results call Erin Callan, its 42-year-old chief financial officer, rattled off lots of figures to prove its strength.

Bear’s leaders were nothing like as hard-working or assertive in defending their bank in the year leading up to its demise. Mr Schwartz, a laid-back corporate financier and former analyst who lacked any experience of running a securities trading business, had put more effort into outreach but lacked the time, and perhaps the appetite, to fight back effectively.

The truth is that Bear’s leadership was old, self-satisfied and inbred. It had become used to telling the same jokes, travelling to the same bridge tournaments and treating the rest of Wall Street with disdain. And when the going got tough, it allowed its institution to perish.