The Weekend That Changed Wall Street

by Maria Bartiromo

  Is there a larger obligation—even a patriotic duty—to protect the markets? I have heard people say that short-sellers are abdicating a core responsibility of citizenship. Short-sellers hate being called peddlers of the system’s destruction. In our system, some companies do well and others don’t. You’re allowed to point out the companies you think are on the wrong track, and bet against them.

  “You can’t put much blame on short selling for bringing companies down,” a source at the Treasury once told me. “Most of the time when the company fails it’s because the company is inherently a bad company. The short-sellers just saw it early.”

  I was interested, though, in what Paulson and Pellegrini saw that others didn’t. In 2010 I asked Pellegrini to describe the reasons for their decision to buck the trend and bet against subprime. He told me that it was not a grand scheme.

  “We were only looking for investment opportunities with a lot of upside and little downside,” he said. “And when we first looked at subprime, we made a general observation that there was generally too much leverage in the economy—and, in particular, there was too much leverage with housing.

  “We were all familiar with the different mortgages that were being offered, including those we had been exposed to personally, and the subprime just didn’t make any sense. We started investigating that, and since it was so inexpensive to bet against those mortgages, we started doing that, too, in a fairly conservative way. It took time for us to understand all of the intricacies and solve some of the puzzles. For example, why didn’t these mortgages go bad faster? What was propping them up? Asking those questions led us to investigate the housing practices of the lenders with respect to pricing, appraisals, refinancing, and the whole operating philosophy. How could they expect to keep borrowers current despite the fact that the borrowers really didn’t have the wherewithal to pay the mortgages?” It was, I realized, the question too few people were asking—at least not publicly.

  It turns out there were plenty of worried faces at the Treasury as early as the summer of 2007. Hank Paulson viewed the freeze of the credit markets with growing alarm. Sure, the stock market was booming, but he could see the underlying paralysis beginning to form. “No one voiced it publicly,” a former Treasury official told me. “But behind the scenes we were thinking that any moment Armageddon was going to happen.”

  Bear Stearns, the eighty-five-year-old investment bank, was considered something of a cowboy firm, and that reputation was personified by its seventy-four-year-old, swashbuckling, cigar-chomping leader, Jimmy Cayne. That Cayne was the face of Bear Stearns was galling to some, who found him an indifferent administrator and personally embarrassing. The rap on Cayne was that, in his later years, he preferred playing golf and bridge to running Bear, although some of his executives defended him as being unconventional yet brilliant.

  The most destructive legacy of Cayne’s reign would be the way he allowed individuals at Bear to construct their own unsupervised fiefdoms. One of these was Ralph Cioffi, who ran a fund backed by home mortgages. In 2007, as the mortgage market tanked, Cioffi found himself stuck with billions of dollars of mortgage-backed securities that nobody would buy. What to do? Cioffi came up with a scheme to repackage them, using a new public company called Everquest Financial. Through his new company, Cioffi hoped to unload his bad securities.

  But the scheme was outed by the business press, and Bear Stearns was forced to withdraw the offering. It would later mean a federal indictment for Cioffi, but he was ultimately acquitted of all charges. However, the chief effect of the failed offering was to turn a floodlight on Bear’s problems—in particular, weak, inattentive leadership.

  One person growing disillusioned with Cayne’s performance was Bear’s eighty-one-year-old chairman, Alan “Ace” Greenberg. A Bear lifer who started as a clerk in 1949 and was CEO from 1978 to 1993, Greenberg was notorious as an administrative tightwad, recycling paper clips and rubber bands to hold expenses down. He had a reputation for being a man of integrity—an example being his dictate that company officers give 4 percent of their gross salary to charity. In many respects, Greenberg was an old-fashioned banker who didn’t appreciate the fast-and-loose climate of Cayne’s regime. He and Cayne had always been very close, but now their relationship was feeling the strain. In 2010 Greenberg would write a book, The Rise and Fall of Bear Stearns, detailing his many grievances against Cayne. Among them was Cayne’s unabashed striving for prestige. “In Jimmy’s case, that hunger for money and status, and the gamesmanship that went with it, indicated an insecurity that was no blessing at all,” he wrote.

  When I asked Greenberg what went wrong, he seemed pained by his falling out with Cayne, although the end was inevitable in light of Cayne’s behavior. “His relationship with me certainly changed over the years,” Greenberg told me. “If I said something was white, he said it was black.”

  On November 1, 2007, the Wall Street Journal published a scathing critique of Cayne, portraying him as a modern-day Nero, playing bridge while Bear Stearns burned. In particular, the article cited Cayne’s absence during the summer meltdown of two of Bear’s hedge funds. He was at a bridge tournament in Tennessee where there was no cell phone or e-mail access. The article also mentioned reports that Cayne smoked pot in his Bear Stearns office, which, combined with everything else, made him look sloppy and irresponsible.

  With Bear’s stock falling, the article could not have come at a worse time for Cayne. After the company announced in December that it would write down $1.9 billion in mortgage-related securities and suffer the first quarterly loss in its history, the board demanded Cayne’s resignation. He agreed to go quietly. He was replaced by Bear president Alan Schwartz, a Brooklyn-born financier who had been with the company for thirty-two years. Schwartz was a Cayne loyalist, but he couldn’t have been more different. He was a skilled and experienced manager, and given a bit more time, he might have pulled Bear out of the hole. But Schwartz didn’t realize when he took over as CEO that the firm had just about run out of time. Throughout January and February things only grew worse as Bear was assaulted by a constant drumbeat in the media about its problems. Schwartz was outraged by the reports—especially those made by Charlie Gasparino, then a reporter for CNBC. Gasparino was amping up the rhetoric to a fever pitch, saying that Bear Stearns was worried about a run on the bank, not by short-sellers but by its prime customers. Schwartz fought back as best he could. He claimed that Bear’s problems were being wildly overstated, as part of a media-fueled feeding frenzy. Bear Stearns, he insisted, was solid.

  On Wednesday, March 12, 2008, the headlines were focused on the shocking downfall of New York governor Eliot Spitzer, who resigned that day in the wake of revelations that he’d regularly had sex with prostitutes. It was a big story for those of us in the business media. When he was attorney general, Spitzer had been the self-appointed avenging angel of Wall Street who seemed to relish the perp walk for high-profile financiers—even though he didn’t always have the goods on them before he brought them down. There was no small glee on Wall Street at Spitzer’s fall into the tabloid muck in light of the purity tests he imposed upon the financial community, although some people had a classier response. “I don’t get any joy out of anyone’s pain,” Larry Fink of BlackRock told me, adding that “the market always gets overjoyed with other people’s pain, whether it’s other firms losing money or other executives falling down.” He didn’t share the excitement, calling it nothing more than an ugly moment in New York.

  A secondary story we had been tracking all week also involved pain on many levels—pain for employees and stockholders of the venerable Bear Stearns. Rumors had been intensifying that Bear was running out of cash, and those rumors had a paralyzing effect on cash flow to the struggling investment bank.

  On that Wednesday, Schwartz reluctantly appeared on CNBC to try to stop the rumors. He insisted once again that Bear was healthy and claimed not to know where the rumors originated. “Part of the problem is that when specu
lation starts in a market that has a lot of emotion in it, and people are concerned about the volatility, then people will sell first and ask questions later, and that creates its own momentum,” he said plaintively.

  His point was well taken, but was it accurate to say that Bear Stearns was merely a victim of the rumor mill? Granted, the financial press has a key role to play and must play it responsibly to prevent overreaction or false reactions in the market. But there seemed to be a lot of rot under the surface at Bear, and it was disingenuous to blame the media. Watching Schwartz, I thought, “Don’t shoot the messenger. What’s the real truth?” False optimism is never warranted, and the consequences are very real. A source of mine complained quite angrily about Schwartz. After watching him give assurances on CNBC, my source bought shares in Bear Stearns and ended up losing a million dollars.

  Today, looking back on Schwartz’s claims of solvency during a period when clearly Bear was about to fail, I want to give him the benefit of the doubt. At the time, Bear had a strong balance sheet, so Schwartz’s claim was essentially true. What he didn’t measure was the destructive effect of a run on the bank. It was a slippery slope. The markets move fast, and at the hint of trouble, a run on Bear could demolish it.

  Jamie Dimon was a youthful fifty-two—shrewd but personable, with one of the best résumés on the Street. He was born on Long Island of Greek heritage, a twin who was also the son and grandson of stockbrokers, and he chose to follow in their footsteps while forging his own identity. As a young man he was irreverent, long-haired, and bright, and he retained his shaggy style through Harvard Business School.

  More than anything, what may have determined Dimon’s future was his choice of a mentor—a friend of the family named Sandy Weill, who had just become president of American Express. Weill had made a name for himself as brilliant but iconoclastic, and he was happy to take Dimon under his wing. After graduating from Harvard, Dimon accepted a job with Weill, as his assistant at Amex. As Weill’s protégé, Dimon was whip smart and deeply loyal. The two men were like father and son, and Dimon was so attached to his mentor that when Weill resigned from Amex in 1985 because the firm wouldn’t make him chairman, Dimon followed him out the door. They experienced some lean years together, but by 1998 they had come back with a vengeance, building the empire that would become Citigroup. By then their bond was so tight that everyone expected Dimon to be Weill’s successor when he eventually retired. But that didn’t come to pass.

  If Weill had an Achilles’ heel, some people felt it was his outsize ego. He enjoyed being the headmaster, the man in the spotlight. Citigroup’s name was synonymous with Weill, and he wanted to keep it that way. As long as Jamie Dimon stayed in his place as the obedient, subservient son and heir-in-waiting, Weill was pleased with him. But when Dimon began establishing his own reputation and getting noticed by the press, Weill became touchy about not being the total center of attention. Although Dimon was hardly a media hound, the press warmed to the young, handsome financier, and he couldn’t always control it. As a result, the relationship between the two men began to fray. Then Dimon did the unthinkable—at least from Weill’s standpoint. He disrespected a member of the family.

  Weill’s daughter, Jessica Bibliowicz, had joined the firm, and by all accounts Dimon welcomed her. But then Weill asked Dimon to put her in charge of Smith Barney, a unit of Citi. Dimon demurred, politely but firmly telling Weill that she was not ready to take on such a big responsibility. When Weill’s daughter resigned rather than accept a lesser position, Dimon’s goose was cooked. Weill could never look at him the same way again. He’d betrayed the king. Off with his head. In 1998 Weill fired Dimon.

  Later Weill wrote a book, which he told me was a cathartic effort to get over the pain of the separation. “Jamie was incredibly smart and unbelievably loyal,” he said sadly. “He was a terrific partner who I really loved, and I hated to see our relationship come to an end. Unfortunately, it had to.”

  Weill’s version implied that the split was Dimon’s doing, and with a guy like Weill, there could be no convincing him otherwise. Dimon wasn’t talking. He may have been deeply wounded by Weill’s actions, but he kept his feelings to himself. Eventually he bounced back, becoming the CEO of Bank One, which he then sold to JPMorgan Chase for $58 billion—a deal widely praised as good for everyone. In 2004 Dimon became the president and chief operating officer of JPMorgan and was made CEO the following year. He was admired on Wall Street and in Washington, and his recent claim to fame was that he’d limited JPMorgan’s exposure to subprime. He was also beloved by his people. One of his lieutenants told me, “Jamie inspires confidence,” and his team was extremely loyal to him.

  On the evening of Dimon’s fifty-second birthday, Thursday, March 13, he received a desperate call on his cell phone from Alan Schwartz. JPMorgan was the clearing bank for Bear Stearns, and Schwartz put it to him straight: he needed $30 billion, and he needed it now. Dimon was shaken by the immediacy of the request, and he told Schwartz it was impossible—at least not without some kind of federal guarantee. He suggested that Schwartz put in a call to Timothy Geithner at the Federal Reserve.

  Geithner took the call from Schwartz and sprang into action. Schwartz had warned him that bankruptcy was imminent without a rescue, and he was grim as he began to work the phones. He realized how damaging it was to be caught so off guard. Only days earlier Christopher Cox, chairman of the SEC, had told reporters, “We have a good deal of comfort about the capital cushions” at Bear. What the hell had happened?

  Geithner’s concern went far beyond the fate of a single investment bank. He believed Bear’s struggle was a gateway to a systemic crisis that could have a devastating impact on U.S. and global markets. He likened it to a spreading contagion, whose origins were small but whose rapid, multiplying effect could bring down the financial infrastructure.

  “The news that Bear’s liquidity position was so dire that a bankruptcy filing was imminent presented us with a very difficult set of policy judgments,” he would explain to a congressional committee months later. “In our financial system, the market sorts out which companies survive and which fail. However, under the circumstances prevailing in the markets the issues raised in this specific instance extended well beyond the fate of one company. It became clear that Bear’s involvement in the complex and intricate web of relationships that characterize our financial system, at a point in time when markets were especially vulnerable, was such that a sudden failure would likely lead to a chaotic unwinding of positions in already damaged markets. Moreover, a failure by Bear to meet its obligations would have cast a cloud of doubt on the financial position of other institutions whose business models bore some superficial similarity to Bear’s, without due regard for the fundamental soundness of those firms.”

  Whether or not Geithner’s analysis was accurate, there is no question that his response to the crisis was forceful and immediate. On the Thursday that Schwartz sounded the alarm, he assembled teams in New York and Washington, D.C., that worked overnight to study the situation and come up with potential solutions. A group of examiners was dispatched from the New York Fed to examine Bear’s books. Geithner also held conversations with Dimon, who reiterated his contention that JPMorgan was a potential purchaser but would require a federal backstop. Dimon was not willing to take a big risk. His primary obligation was to his own shareholders. He also knew far more than other banks as he was the lender to some of those vulnerable institutions.

  As dawn broke over lower Manhattan Friday morning, Geithner held another conference call with the Fed board of governors and members of the Treasury Department to review the options and decide on a way forward. They settled on a stopgap measure to buy some time. With the support of Treasury secretary Paulson, Fed chairman Bernanke, and the board of governors, it was agreed that the New York Fed would help engineer a rescue.

  The arrangement that was presented to Schwartz on Friday morning was nothing short of a lifeline. JPMorgan Chase would issue a credit
line, backed by the Fed, good for twenty-eight days. Schwartz, who had never accepted that his company was on the brink of ruin, believed he could secure capital or engineer a lucrative sale in that period of time. But that’s when things got weird. Late Friday, Geithner told Schwartz he didn’t have twenty-eight days, after all. The federal money would be available only for the weekend. Schwartz was stunned. He felt betrayed, although he subsequently shrugged it off as a misunderstanding on his part: he thought they’d said twenty-eight days; they’d actually said two.

  To this day it isn’t entirely clear what happened. It seems unlikely that Schwartz was confused. With his company in dire jeopardy, would he make such an error? More plausible is the explanation that as they studied Bear’s books, the Feds decided the risk was too great. The cord had to be cut by Sunday night.

  Overnight deals are the most stressful kind, especially when the stakes are so high. While several firms initially expressed interest in Bear Stearns, it was nearly impossible to perform the due diligence, create a plan, and get the approvals in the space of forty-eight hours. The question was, who had the nerve, the independence, and the cash to make it work? The answer kept returning to JPMorgan Chase. By late Saturday it was the only buyer left. But the deal was constantly threatened by the hard realities Dimon’s people faced as they scoured Bear’s books.