Last Man Standing

by Duff McDonald

  Remarkably, as Bear teetered on the edge, a key member of its leadership for some reason concluded that being out of town was acceptable. Alan Schwartz, then CEO, was in Palm Beach at the luxurious Breakers resort for the company’s annual media conference, a confab at which he mingled with Time Warner’s Jeff Bewkes, Disney’s Robert Iger, News Corp’s Rupert Murdoch, and Viacom’s Sumner Redstone. He chose not to rush back to New York to take charge.

  Schwartz issued a press release on March 10 claiming that the company’s “balance sheet, liquidity, and capital [remained] strong.” The company was sitting on $18 billion of cash, he told investors and counterparties; there was nothing to be concerned about. Not true. The firm was dangerously leveraged, with just $11.1 billion in tangible equity backstopping $395 billion in assets. Worse, trading partners were now leaving in droves.

  On Tuesday, March 11, the Federal Reserve made an unprecedented move—it decided to open its discount window to investment banks for the first time, allowing them to borrow up to $200 billion in Treasury securities in exchange for any mortgage-backed collateral the banks might provide. The hitch: the program would not commence until March 27. Charlie Gasparino suggested on CNBC that the Fed’s moves were clearly aimed at helping Bear. The only question was whether that help would come in time. Another Dutch bank, ING, told Bear it was withdrawing $500 million of financing. Rabobank, which had already done the same, signaled that it would also not renew a $2 billion loan coming due the next week. Adage Capital, a hedge fund, removed its money from Bear’s prime brokerage arm that day, and other hedge funds were making noises about doing likewise. Fidelity Investments, which had been an overnight lender to Bear to the tune of $6 billion a day, pulled its funding during the week. Federated Investors, into Bear for $4.5 billion a night, also reneged.

  William Cohan suggests in House of Cards that the “dirty little secret” of Wall Street firms was just how much they relied on such overnight “repo” funding. He was right. Although there was always the risk that a firm might lose its access to short-term funds instantaneously—and thus be left unable to repay its obligations—this hadn’t happened to any major firm in memory, and the risk was therefore essentially ignored. Until it couldn’t be.

  That same day, the chief of the New York Fed, Tim Geithner, and the Fed’s chairman, Ben Bernanke, hosted a luncheon in the Washington Room at the New York Fed on 33 Liberty Street. The CEOs of most of the top Wall Street firms were in attendance—Lloyd Blankfein of Goldman Sachs; Ken Chenault of American Express; Dimon; Dick Fuld of Lehman Brothers; Bob Rubin, chairman of the executive committee at Citigroup; and John Thain of Merrill Lynch. A few kingpins of private equity and hedge funds were also there, including Ken Griffin of Citadel Investment Group, Bruce Kovner of Caxton Associates, and Steve Schwarzman of the Blackstone Group. There was no one representing Bear Stearns in the room; Schwartz had not even been invited.

  On the morning of Wednesday, March 12, Schwartz appeared on CNBC in an effort to deflect growing concerns about the company. “Some people could speculate that Bear Stearns might have problems, since we’re a significant player in the mortgage business,” he said to the anchor, David Faber. “None of those concerns are true.” If this was not an outright lie, it was surely a twist of the truth. The previous day three banks—Credit Suisse, Deutsche Bank, and Goldman Sachs—had all received numerous “novation” requests from investors seeking to have someone take over Bear’s side of various derivatives trades.

  Schwartz returned to New York on the afternoon of March 12. That evening, he called the banker Gary Parr, of Lazard, who was watching Patrick Stewart in a performance of Macbeth in Brooklyn. Parr left at intermission and met the Bear executives at their offices to discuss their “strategic options”—Wall Street’s code for a fire sale. Schwartz also called H. Rodgin Cohen, the chairman of the law firm Sullivan & Cromwell. After a brief discussion, according to the Wall Street Journal, Cohen dialed Tim Geithner and asked if there was any way the Fed might accelerate the timing of the opening of the discount window. “I’ve been around long enough to sense a very serious problem,” Geithner told him. “If he’s worried, Alan needs to call me.”

  Schwartz did call Geithner the next day to brief him, but maintained that he hoped to find a solution without the Fed’s help. He was kidding himself. By this point things were moving so quickly that there was little for him and his colleagues to do but watch the money stream out the door. That morning, the hedge fund Renaissance Technologies took $5 billion out of Bear’s prime brokerage arm. In the afternoon, another hedge fund, D.E. Shaw & Co., did the same thing.

  At the day’s end, Bear had just $5.9 billion of cash on hand, and the company’s stock price was plummeting. Gary Parr was working the phones, trying to find what he called a “validating” investor—an outsider who could lend credence to the idea that Bear was still viable. One of the first people on his list was Jamie Dimon.

  At the same time that Alan Schwartz’s world was falling apart, Jamie Dimon was settling into his comfort zone. While JPMorgan Chase had chased market share during the credit boom—by loosening loan covenants or adjusting pricing downward along with the rest of the herd—their relatively disciplined approach had left Dimon and his operating committee in position to pick off a weakened competitor or two if the turmoil continued. In January, JPMorgan Chase had bought $4.3 billion in reverse mortgages from the struggling U.K. bank Northern Rock at a steep discount. “We are one of the few people that everyone knows are open for business and ready to work on some of these things,” Bill Winters said at the time.

  On the afternoon of March 13, in fact, a number of executives, including the chief financial officer Mike Cavanagh and Charlie Scharf, sat in an eighth-floor conference room at 270 Park Avenue, getting ready to go to Seattle the following Monday. Washington Mutual, the Seattle-based bank, had run aground because of its own subprime mortgage troubles and had put itself up for sale. There was also the possibility that one of the Ohio-based banks might be on the block, and Dimon intended to bid aggressively for at least one of the two.

  Around 6:00 P.M., Dimon stuck his head through the doorway of the conference room. It was his fifty-second birthday, and he was heading out for dinner with his wife, his parents, and his eldest daughter, Julia. The celebration was to be at Avra, a Greek restaurant that was a favorite of his parents. “I got another call from someone who wants us to consider buying their company,” Dimon said, almost in passing. To no one’s real surprise, the caller had been Gary Parr, on behalf of Bear Stearns. “But it didn’t have a tone of ‘This is going to happen in the next 12 hours,’” recalls Cavanagh. “It was more like we should spend some time to see if something would make sense between the two companies. All by itself, given the environment, it wasn’t a strange or alarming bit of information.”

  An hour later, during dinner, Dimon’s cell phone rang. It was Parr, asking him if he had a moment to speak to Alan Schwartz. As Dimon walked outside to the sidewalk, the CEO of Bear Stearns cut to the chase. “We really need help,” Schwartz said. “How much?” Dimon replied. “As much as $30 billion,” was Schwartz’s response. “Well, the answer to that one is easy,” said Dimon. “No.”

  But Schwartz was desperate. He asked if Dimon would consider a mere overnight loan. “I can’t; it’s impossible,” said Dimon. “There’s no time to do the homework. We don’t know the issues. I’ve got a board.” Dimon suggested that Schwartz call both the Federal Reserve and the Treasury Department, and told Schwartz he would be in touch. And then he hung up.

  Dimon left dinner, went home, and was on the phone for much of the night. The first of his flurry of phone calls was to Tim Geithner, who urged him to help Bear. Despite the implied threat that regulators can hang over a Wall Street CEO’s head, Dimon wouldn’t be bullied. “Tim, look, we can’t do it alone,” he said. “Just do something to get them to the weekend. Then you’ll have some time.” The two agreed to continue the conversation later. Dimon also spoke to Secret
ary of the Treasury Hank Paulson and to the Federal Reserve chairman, Ben Bernanke.

  He also called Steve Black, who was on vacation in Anguilla with his wife, Debbie. At dinner in a beachside restaurant, Black knew something was up when a man came striding urgently toward his table. “Are you Mr. Black?” he said. As had happened so many times before, an investment banker trying to enjoy a vacation had been tracked down by his boss. In short order, Black was on the phone in the restaurant’s kitchen with Dimon. Black returned the next day to take control of the investment bank’s efforts in New York; in the meantime, Bill Winters (who received another call) led the team by phone from London on Thursday night and Friday morning.

  Yet another call was to Mike Cavanagh, who by that point was at home for the night. “Jamie rarely calls in off-hours and is pretty respectful of family and weekend time,” recalls Cavanagh. “So I knew something was up.” After a quick briefing, Cavanagh was on the phone with John Hogan, the chief risk officer of JPMorgan Chase’s investment bank. He then spoke with the chief financial officer of Bear Stearns, Sam Molinaro, and its treasurer, Robert Upton.

  The executives at JPMorgan Chase were surprised to discover how baffled the executives at Bear Stearns were about what was happening. Instead of presenting a crisp request—“Here’s what we need, J.P. Morgan: x billion dollars”—Bear’s executives tossed out numbers ranging anywhere from $5 billion to $20 billion in the span of a single conversation. “The mere fact that it was that wide of a range left us thinking that they really didn’t know how bad it was going to be,” recalls Cavanagh.

  At 11:00 P.M., JPMorgan Chase dispatched a number of credit people to the beleaguered firm’s offices at 383 Madison Avenue, the first of many teams to go to the Bear Stearns building that night, headed by the senior trader Matt Zames. He was joined at 2:00 A.M. by teams from both the Federal Reserve and the Securities and Exchange Commission.

  At 3:00 A.M., Cavanagh received another call from Dimon. “I felt like a fireman at that point,” recalls Cavanagh. Dimon said he was about to get on the phone with the Treasury and the Federal Reserve and needed Cavanagh in the office immediately. An hour later, a bleary-eyed Cavanagh walked into John Hogan’s office, and into the middle of a conference call with Dimon, Tim Geithner, Bill Winters, and Matt Zames. The discussion was still theoretical at that point, as the men speculated blow-by-blow on the events that would occur if Bear Stearns couldn’t open for business. Bear Stearns, after all, had trading positions with 5,000 firms and billions of dollars at risk. “It was a scary description of events that we all thought would lead to more dominoes falling in subsequent weeks,” recalls Cavanagh.

  Dimon essentially demanded all hands on deck on Thursday night. By 6:00 the next morning, he told his team to cut Bear Stearns into numerous slices. He wanted the teams looking at those slices to come back every three hours and give him a sense of their value.

  Government officials had no playbook for this kind of event. They also lacked the power to lend directly to broker-dealers such as Bear Stearns. Somewhere in the wee hours of the morning, a plan began to take shape. Instead of lending directly to Bear Stearns, the Fed would lend $30 billion to JPMorgan Chase, which would turn around and lend that money to Bear.

  The arrangement was termed a “conduit,” though it was really nothing more than a circumvention of the Fed’s own lending restrictions. “It was harebrained,” recalls one executive at JPMorgan Chase. “It wasn’t like we went to ‘Section Five’ of the ‘Emergency Financial System Meltdown Manual’ and found out what we should do.” The outcome, however, was nothing short of profound. For the first time since the Great Depression, the Federal Reserve was going to backstop an investment bank.

  In the four-sentence release announcing the conduit, Stephen Cutler, general counsel of JPMorgan Chase, included a line saying that the secured funding would be good for “an initial period of up to 28 days,” followed by the statement that “JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company.” When Alan Schwartz and Bear’s chief financial officer, Sam Molinaro, received the release in an e-mail from Cutler at 6:45 A.M., they thought this meant that they had 28 days to come up with a solution to their predicament. They were naturally relieved. They shouldn’t have been.

  • • •

  When the stock market opened the next morning, Bear’s shareholders appeared to be relieved as well. The stock floated around its close of the previous day, $57 a share, even climbing to $62 in the first half hour of trading. Steve Black, who’d been up all night helping to get the debt facility in place, was packed and ready to go to Miami with his wife, Debbie, on a 10:00 A.M. flight. At 9:30, he switched on CNBC. He couldn’t believe that the stock hadn’t plummeted.

  Turning to his wife, he said, “The markets don’t have any idea what’s really happening here. Mark my words, by the time we get back to New York, and the market has digested the news, the stock price will have been cut in half.” It didn’t take even that long. When the couple arrived at the airport with their luggage, the stock was already trading at $31 a share. One hundred ninety million shares of Bear traded that day—17 times the daily average, and the stock closed at $30 a share, down 47 percent. The cost of a five-year credit default swap on the company’s debt had risen to $772,000, nearly double that of Lehman Brothers’ $451,000 and triple that of Goldman Sachs’s $253,000. Clients continued to pull out their accounts.

  Alan Schwartz was in a car on the way to his home in Greenwich that evening when Paulson and Geithner called. Geithner delivered the first surprise. The financing from the Fed would not be available on Monday. Paulson delivered the second. A “stabilizing transaction” had to be done by the end of the weekend—in other words, the firm would have to be sold in the next 48 hours. Schwartz later testified, “All the leverage went out the window when a deal had to happen over the weekend.”

  Ever since, many of Bear’s former executives have maintained that Paulson and the Fed played dirty pool by “changing” the terms of a deal made only the night before. Dimon didn’t see it that way. The original goal of the financing was to get Bear to the weekend, at which point he (or any other interested party) could consider buying the company.

  Then there was the exact wording of the press release itself, about which there has been much consternation. It did not say “28-day financing.” It said “up to 28 days.” “I’ve always considered this a moot point,” Dimon said after the eventual purchase of Bear Stearns by JPMorgan Chase, “because they were still having a run on the bank. The Fed had lent them $30 billion on Friday and we had to lend them another $20 billion on Monday. We wouldn’t have done that had we not done the deal, and the fact that we’d done the deal wasn’t even stopping money from continuing to head out the door. So they would have never survived Monday anyway, even if the financing had been for 28 days. It didn’t matter. It was over.”

  What’s more, the lending from the Fed was collateralized, which meant that Bear Stearns needed to have assets to pass on. “The Bear people seemed surprised,” recalls Cavanagh. “But I have no idea why. They didn’t have the collateral anyway.”

  By 8:00 the next morning, Schwartz and Molinaro were back at 383 Madison, meeting with bankers from JPMorgan Chase as well as representatives from the private equity outfit J.C. Flowers & Co., which would prove to be the only other interested party. Other firms had representatives in the building, but none of them mounted a serious bid. Citigroup, obviously, had its own troubles. Bank of America was busy completing a purchase of Countrywide Financial. Goldman Sachs had the resources to buy Bear, but had no reason to—the two firms overlapped too much. But JPMorgan Chase was diving headlong into the deal, dispatching 16 teams from various departments to meet with Bear’s officials and combing through their books.

  The members of JPMorgan Chase’s team were still not entirely sure that they were interested. They were merely doing due diligence at breakneck speed. While several h
undred top executives scurried around the company’s own headquarters at 270 Park Avenue holding meetings—some 2,000 people had been called in to work on the deal globally—Steve Black was thinking to himself, “Didn’t we just do this?” And they had. When Bear’s hedge funds had run into trouble in the summer of 2007, executives at JPMorgan Chase had taken a pass on buying the firm. Six months later, things were even worse for the struggling investment bank. So what was the point of going through the motions again?

  “We’d been through it the past summer,” Black recalls, “and we’d told them that we’d be interested if they wanted us to make some sort of convertible investment in their prime brokerage business. Alan’s response had been, ‘Why would we do that? Wouldn’t it make the whole franchise worth less?’ I’d said, ‘That’s a fair point, but consider this us registering some interest if you guys get to that point.’ We had done the work on whether we’d be interested in the whole bank and the consensus was it wasn’t worth all the aggravation. Certain pieces fit well, but the rest of it would have been too time-consuming to integrate. Plus, at the kind of price Bear was likely to get, it wouldn’t give us much in the end.” The “certain pieces” he was referring to were Bear’s prime brokerage operations—estimated to be worth about $3 billion—its clearing business, and its energy and commodities divisions.

  There was also the building. Constructed at the height of the commercial real-estate market in Manhattan, Bear’s headquarters at 383 Madison Avenue were worth an estimated $1 billion. JPMorgan Chase had recently announced, with Mayor Michael Bloomberg and Governor Eliot Spitzer, its plan to construct a new headquarters for the investment bank in downtown Manhattan, on the site of the old Deustche Bank building, which had been condemned after 9/11. If JPMorgan Chase could nab Bear’s building, it would save itself a whole different kind of aggravation. “We could have taken five years and spent $3 billion to build a new building, or just said, ‘Who cares about the rest of Bear Stearns, let’s just get the freaking building,’” recalls one JPMorgan Chase executive. “I kept saying, ‘Guys, we have to get that building.’” The Bear building is even shaped like an octagon, the symbol of Chase.