Last Man Standing

by Duff McDonald

  The deal aside, JPMorgan Chase wasn’t exactly a fount of good news in April 2008. With the economy suffering its biggest loss of jobs in five years, the bank suffered along with the competition. The company announced a 20 percent sequential drop in first-quarter net income, to $2.4 billion. It marked down $2.6 billion in leveraged loans and mortgages, and quadrupled its credit loss provision to $4.42 billion from $1.01 billion. Return on equity nosedived to 8 percent, down from 17 percent in 2007.

  The company’s closely watched tier 1 capital ratio stood at 8.3 percent, however, well above that of its rivals. “We are prepared to manage through this down part of the economic cycle, given the strength of our liquidity, credit reserves, capital and operating margins, and to successfully position our company well for the future,” said Dimon. Unlike most of his competitors, Dimon had not needed to go hat in hand to foreign sovereign wealth funds for a capital infusion, and the message was that he wouldn’t have to. He had, however, taken advantage of a relative respite in the market’s turmoil to issue $6 billion in preferred stock in an opportunity timed sale. JPMorgan Chase also knocked out Citigroup as Wall Street’s top underwriter in the first quarter of 2008.

  Cayne had regained some of his bearings by the time of the final shareholder vote on the deal on May 29. After the meeting, in which 84 percent of shares voted for the deal (no huge achievement, given JPMorgan Chase’s nearly 50 percent ownership), he made a brief speech. “The company that is taking us over, or is merging with us, is a first-class company,” he said, to the audience. After the meeting, Dimon called Cayne from Positano, Italy, to make sure the vote had gone through. They talked for just one minute.

  In contrast to the wakelike atmosphere of the meeting at Bear, JPMorgan Chase’s annual meeting a few weeks previously had a jubilant feel. Wall Street, for all its pretense to sophistication and complexity, is largely a zero-sum game—someone loses, someone wins.

  In a comic moment at the meeting, Evelyn Davis, an eccentric gadfly shareholder who has exasperated CEOs for decades, stood up and said, “Jamie, you look strikingly handsome.” The crowd laughed and Dimon cracked a smile. “We are fortunate to have Mr. Dimon,” Davis continued, “who is the Dudamel”—she was referring to the conductor Gustavo Dudamel—“of bankers in this country.” Looking flummoxed, Dimon replied, “I hope that was a compliment.”

  • • •

  Despite the fact that he was playing the highest-stakes game in the world, Dimon had never seemed more at ease. When his old college buddy James Long called him on the afternoon of Sunday, March 16, to catch up, Dimon called Long back a few hours later. “We’re just yak-king for a few minutes, and then he says, ‘I have to go. We’re in this negotiation.’ I asked him what negotiation, and he wouldn’t tell me. I even brought up Bear Stearns’ predicament and he gave me thoughtful answers without telling me anything. A few hours later, I see the news of the deal. It was pretty comical.” Likewise, Dimon’s longtime friend Laurie Maglathlin called him on the night of March 13 to wish him a happy birthday. After a few minutes, he said, “Laur, I have to go. I’m really busy right now.” The next day, the Bear conduit was announced.

  The company had said it planned to try to keep about half of Bear’s people. It didn’t come close to that. By February 2009, 10,000 of the 14,000 people employed by Bear before the deal had either left the firm or been laid off. Dimon extended offers to many executives to stay, but in some areas he made almost none at all. Of Bear’s leveraged lending group, for example, only three of 100 people received offers. In asset management, when Bear Stearns brokers demanded the same kind of revenue split they had negotiated with the previous management, they were told in no uncertain terms what they could do with their demands. “They had $28 billion in assets under management when we bought them,” recalls a senior JPMorgan Chase executive. “And we had $1.2 trillion. Theirs was such an ‘I’m for me’ culture that they all thought they would keep their revenue share. We told them, ‘We just bought you. The answer is no. So you either come into our compensation structure or we’ll shut you down.’ And we ended up shutting about 90 percent of it down.”

  Despite reports in mid-April that Dimon had extended an offer to Alan Schwartz to come over to JPMorgan Chase as a nonexecutive vice chairman, Dimon had done nothing of the sort. Dimon took only six people from senior management at Bear Stearns—the former CEO Ace Greenberg, as well as Peter Cherasia, Jeff Mayer, Mike Nierenberg, Craig Overlander, and Jeff Urwin. And three of those six have since left the firm. (Some top earners refused jobs. Shelley Bergman, Bear’s star stockbroker, took $1 billion of client assets with him to Morgan Stanley.)

  There was internal grumbling at JPMorgan Chase when its investment bank laid off thousands of its own staffers shortly after the deal, while hiring new ones from Bear. “They laid off their own people,” says an executive who left the company in 2002. “Why would you fire a single person on your own team? The morale hit was not insignificant.”

  Despite job-saving offers, many Bear employees chafed at the notion of working for JPMorgan Chase. Those with other options walked right out the door. Bear Stearns was an entrepreneurial place, and that fact ultimately caused its downfall. JPMorgan Chase was viewed as a widget factory, where everything fit into its own little box. That’s the smart way to run an organization with $2 trillion in assets, but it’s not a recipe for fun, if fun is what you’re looking for in a job. There are a number of longtime JPMorgan Chase employees who say that since Dimon arrived in 2004, he has made the place even less fun. His response? “So what?”

  Dimon told Charlie Rose that it was unlikely JPMorgan Chase would be in the market for another 48-hour deal any time soon. “If I took a phone call like that again and called up the team and said, ‘We have to go do this again,’ I think they’d shoot me.”

  Steve Black, who shouldered the largest part of the negotiations along with Bill Winters, probably would. Prior to this deal, he had always answered the question as to whether JPMorgan Chase would do a deal with an investment bank simply, “Over my dead body.” Continuing, he would argue, “There is so much overlap that combining the revenue streams would be like adding ‘1 + 1’ to come up with 1.2. You also have to effectively pay for the company twice because of the amount you have to shell out to convince the people you want to come on board.” In retrospect, he says, “There are four reasons Bear worked. First, it wasn’t a real full-scale wholesale investment bank. It had bits and pieces, but it wasn’t like trying to merge with Goldman Sachs or Morgan Stanley. Second, they had some things we didn’t have, like prime brokerage and the commodities businesses. Third, given the price we paid, we could pay people to stick around without it costing double in the end. And fourth, those payments weren’t too onerous, as the market for people was itself under pressure at the time. That’s why we have an opportunity to create some value here.”

  Perhaps. But it will take longer than JPMorgan Chase had hoped. It had estimated that the cost of the deal would be about half of Bear’s book equity, but the cost turned out to be all of that and more. Instead of a cost of $6 billion to “de-risk” the balance sheet, by November 2008 the total was closer to $15 billion. (Remarkably, one source of significant loss was a “macro” hedge Bear Stearns had against most of the deteriorating positions on its books. When the deal was announced, most markets rallied—equities, fixed income, mortgages—sending the value of the hedge plummeting.) The margin of error Cavanagh had spoken so confidently about was too small. Although Dimon still projected getting $1 billion to $1.5 billion in annual earnings out of legacy Bear Stearns businesses by the end of 2009, the deal’s economics didn’t look so good anymore.

  To say that the deal was not costly would be a mild understatement. “We were selling into the worst market environment ever, and it cost us a lot more than we would have wanted,” says Black. A sore spot among JPMorgan Chase executives is just how much of that pain should have been taken by Bear Stearns before the deal and not by JPMorgan Chase after
ward.

  On the other hand, some parts of the deal have worked out exactly as planned. There was the building, for one. And even though the prime services unit continued to hemorrhage clients in the wake of the deal, getting a foothold in the business positioned JPMorgan Chase to vacuum up business when Lehman Brothers failed in September 2008 and both Goldman Sachs and Morgan Staneley were on the ropes. By the end of the year, customer balances were back to peak premerger levels. In the first quarter of 2009, JPMorgan Chase snagged the second spot in prime brokerage market share with nearly 20 percent, up from precisely zero the previous year.

  Winters would do it again, but differently. “Had we had a crystal ball about the market, we would have been much more aggressive in terms of moving the risk out earlier. We would have sought a greater backstop from the U.S. government. And we would have been more aggressive when it came to cutting costs. We tried to approach it as a merger, and we were too gentle.”

  On March 17, 2008, Dimon spoke optimistically about what he saw as the coming end of the market’s crisis. His logic was straightforward. Massive de-leveraging was going on at financial institutions, alongside massive capital raising. With no new production of securitized mortgage product, supply and demand had to come into balance at some point—hopefully in 2009. As a result, he suggested that the “financial side” of the market turmoil was probably already half over at that point. He couldn’t have been more wrong. The turmoil was just getting started.

  In subsequent months, the deal with Bear was eclipsed by even bigger events—the failure of Lehman Brothers, the near-failure of AIG, and the takeover of Merrill Lynch by Bank of America. And that’s as it should have been. Bear Stearns, for all its bluster, was too small to matter in the grand scheme of things. Just over a year later, there was absolutely nothing left of the Bear Stearns name save for a small group of high-end brokers kept on at JPMorgan Chase. (By February 2009, Dimon hadn’t even found a spot for Bear in a warren of private dining rooms on the fiftieth floor of the company’s headquarters paying homage to predecessor companies such at Manufacturers Trust and the Bank of Manhattan. Bear Stearns executives didn’t seem to care much about history in any event. When JPMorgan Chase’s archivist Jean Elliott went to seek out Bear-related historical materials to add to the company’s extensive archives after the acquisition, she found nothing but a pile of annual reports.)

  • • •

  Reputations were made, destroyed, and burnished during that tumultuous week in March. Paulson, Bernanke, and Geithner received largely positive press, even if some observers questioned the long-term implications of the government’s role in the deal. They had managed to calm the market, had taken out a weak player, and had opened up the discount window at what seemed a critical moment. It all looked fairly smart at the time. All three were later roundly condemned for seemingly haphazard responses to the more dramatic events that came later.

  Bear Stearns was neither the greatest deal of all time nor even Dimon’s greatest deal. Merging Bank One and JPMorgan Chase was a far more important event with greater ramifications for Dimon’s career. Was Bear even a good deal for JPMorgan Chase’s shareholders? Dimon said at the time that it would be unfair to judge the deal until a year after the fact. “You cannot judge us on this deal today,” he said in May. “We are bearing an awful lot of risk. We are pushing as fast as we can to get it done.” Still, by the summer of 2009, it wasn’t looking as if it had been worth the effort, at least in terms of dollars and cents. An often overlooked fact is that in doing the deal, JPMorgan Chase paid two costs: the cost of the deal itself and the opportunity cost of deals it might otherwise have done. The latter is a theoretical issue, but it’s quite possible that the opportunity cost was large.

  Here’s what the deal accomplished. It established Dimon as Wall Street’s banker of choice, and buffed JPMorgan Chase’s reputation to such a high shine that the firm was still benefiting a year later, even as its business continued to deteriorate along with the economy. “In the end, it was a tough deal,” recalls the head of asset management, Jes Staley. “With one exception. What it did for our reputation was worth every penny. It was unbelievable. Absolutely.”

  The result of this enhanced reputation was tangible. The company had $400 billion in money market funds under management at the end of 2007. It took in another $200 billion in 2008 alone. Other divisions experienced similar gains. JPMorgan Chase’s commercial banking division, for example, saw 2008 net income surge 27 percent to $1.4 billion even as recession gripped the country.

  As Bear had proved, reputation is everything on Wall Street. As Bear’s own standing was diminished, Jamie Dimon’s rose to towering heights. Bank of America’s CEO Ken Lewis hadn’t even merited a call when the governors of the Federal Reserve went looking for a rescuer. By calling Dimon, they signaled that they were looking for strong hands at a crucial time for the markets. But they were also making official what a growing number of people already knew. Almost a century after its heyday, JPMorgan Chase—and by extension Dimon himself—was once again the country’s bank of last resort.

  13. THE NEW POWER BROKER

  In the immediate aftermath of the Bear deal, optimism surged about how federal authorities and the private sector had come together to protect the financial system. From its low on March 7, 2008, through May 2, the stock market rallied nearly 10 percent. So what if there was a little moral hazard here, a little government intervention there, the popular thinking went. Better a flawed system than a completely busted one.

  On March 18, Lehman Brothers, widely considered the next weakest firm on the Street, announced first-quarter results that were better than expected, boosting its shares 32 percent that morning. Lehman had posted strong results in a few businesses, such as mergers and acquisitions advice and equities, but it also wrote down $1.8 billion of mortgage-related assets. Analyst Mike Mayo (now at Deutsche Bank), a man not known for his sunny forecasts, declared, “Lehman is not Bear.” In a piece in late April, The Economist magazine said, “That Lehman did not implode is thanks, in part, to the Federal Reserve’s decision to lend directly to securities firms for the first time.”

  Bank executives tried to see past the crisis. Morgan Stanley’s CEO, John Mack, told shareholders that the subprime crisis was in the eighth or ninth inning. Goldman Sachs’s CEO, Lloyd Blankfein, ventured the opinion that the markets were in the third quarter of the game. Dimon himself was optimistic that the credit crunch might be easing, but he was still disturbed by the weakening economy: “I told my investment banking friends, ‘Lucky for you, you’re probably through a big part of your pain. It’s continuing for some of us with real credit exposures to consumers.’”

  Although Dimon was right on that last point, all three were wrong about the credit crunch. By the summer, Lehman and Merrill were fighting for their lives. Lehman Brothers got in a pitched public battle with the hedge fund manager David Einhorn, who aggressively shorted the company’s shares, convinced that its accounting couldn’t be trusted. He was also convinced that the bank was cooking its books. A $2.8 billion second-quarter loss at Lehman—the company’s first quarterly deficit in 14 years—thoroughly spooked the market, and by the end of the month the Dow Jones was in bear market territory. The rest of the summer was just one piece of bad news after another. In July, the government seized IndyMac Bank; this was the second-largest bank failure in U.S. history. Regulators also had to reissue a warning to Citigroup that pursuing any major acquisitions would be unwise in its current state.

  The price of oil had gone sky-high—it reached $147 a barrel in July—and short sellers were chasing Merrill and Lehman like bloodhounds after a fugitive. John Thain, Merrill’s CEO, had turned into the second coming of Citigroup’s Chuck Prince, a man who could be counted on to say one thing and then do precisely the opposite. On April 10, Thain said that the company’s cash reserve was “sufficient for the foreseeable future.” Twelve days later, Merrill Lynch raised $9.5 billion through an issuance of debt a
nd preferred stock. In May, he said, “We have no present intention of raising any more capital.” On July 29, Merrill Lynch tapped the capital markets once again, to the tune of $8.5 billion. On July 18, he said, “I don’t think we want to do dumb things. We have been pretty balanced in terms of what we sold, and at what prices we sold them. We have not liquidated stuff at any prices we could get.” Ten days later it emerged that Merrill had unloaded $30.6 billion of super-senior ABS CDO product into the market at 22 cents on the dollar. (In retrospect, it is amazing that Merrill made so many moves to shore up its finances yet still found itself insolvent come the fall.)

  August, normally a slow month for financial companies, took a toll on JPMorgan Chase. On August 14, the company announced that it was buying back $3 billion in auction-rate securities from investors in a settlement with regulators over whether the company’s salespeople had misled their customers about attendant risks. For Dimon, who had a reputation for integrity, this was a bitter pill. (As his predecessor John Pierpont Morgan had said about a banker’s reputation at the Pujo hearings in front of the House Banking and Currency Committee in 1912, “[It] is his most valuable possession; it is the result of years of faith and honorable dealing and, while it may be quickly lost, once lost cannot be restored for a long time, if ever.”) At the end of the month, the company announced that holdings of preferred stock in the mortgage giants Fannie Mae and Freddie Mac had lost about half their value, resulting in a $600 million write-down. On September 3, Dimon shut down a division that sold derivative securities to municipalities amid a government investigation into questionable sales practices there as well.