'THE CULPRITS - True Lives of the Credit Crunch Bankers.'

THE IDEA :

The events of September and October 2008 ...

THE DUST JACKET :

EXTRACT :  (Copyright 2009)

Chapter 1 - The House of Cards

‘I just got my butt kicked.’

James E. Cayne, Chief Executive Officer,

In the early hours of 11th September 2007 an anonymous black sedan pulled up outside an exclusive private residence on Park Avenue, New York City. Its purpose was to transport the occupant to hospital. Inside, James E. Cayne, 73, chief executive of the nations fifth largest investment bank lay dangerously ill, probably even close to death.

Cayne had awoken earlier in the morning complaining of weakness and a loss of appetite. His wife Patricia called their doctor who saw Caynes rapid deep breathing and high blood pressure, and who suspected sepsis, a serious medical condition akin to blood poisoning. He recommended that Cayne be taken to hospital immediately by ambulance. Cayne disagreed and instead summoned a town car to take him. His investment bank had taken a public hammering in prior weeks and he had no wish to be seen being stretchered into an ambulance on Park, nor to be seen getting out of one outside the New York Presbyterian Hospital in Manhattan. Doctors at the hospital located the infection in his prostate. They gave him a 50/50 chance of survival and kept him in hospital for ten days while they pumped him with 22 gallons of saline infusions. Cayne lost 30 pounds but he survived.

Cayne was not wrong. He was Bear Stearns, or ‘Bear‘, as the 14,000 staff liked to refer to their firm. Bear Stearns was founded in 1923 as an equity trading house by Joseph Bear, Robert Stearns and Harold Mayer, but somehow Mayer never got to have his name up in lights. Cayne had spent 38 years there and he had been well rewarded. He owned 5.66 million shares in Bear Stearns Companies (NYSE code : BSC) which at the all-time-high stock price of $172.69 in January 2007 were worth almost $1 billion. However at the time of his illness, the stock price had already fallen markedly to a mere $105. But suffice to say when it came to settling his typically exorbitant US hospital bill, he had little trouble.

Cayne only garnered his job at Bear Stearns because he played bridge. In 1969 he was interviewed by Harold C. Mayer Jr., the son of the same older Harold Mayer, but there was no chemistry between them and the interview was going nowhere fast until Mayer asked him to meet Alan ‘Ace’ Greenberg, who was already marked out as the firms future CEO. Again there was little chemistry, until Greenberg finally asked Cayne if he had any hobbies. ‘I said, 'Yes, I play bridge. You could see the electric light bulb. He says, 'How well do you play?' I said, 'Mr. Greenberg, if you study bridge the rest of your life, if you play with the best partners and you achieve your potential, you will never play bridge like I play bridge.’ Greenberg offered Cayne a job as a stockbroker on a $70,000 salary. He even coined a name for all his new hires at the time: PSD’s, for poor, smart, and a deep desire to get rich. Cayne’s own bridge partner later opined to The New York Times about his fortunate friend; ‘He didn’t go to Harvard Business School - he was a bridge bum.’

Cayne was born in 1934 in Evanston, Illinois. He attended Indiana’s Purdue University but he mostly played bridge and he left one term before graduating. ‘I don't read and absorb. I hear and I absorb.’ He drove a cab in Chicago, sold photo-copiers (during his days as a travelling salesman he almost died when his car hit a utility pole), got married, worked in his father in laws scrap-iron business (‘If you can sell scrap metal,’ a Bear legend quotes Greenberg telling Cayne, ‘you can sell bonds‘), but ultimately he left an unfulfilling career and a broken marriage in Chicago to go to New York to become a professional bridge player.‘People, for whatever reason, think, if you're a good bridge player you've got a good brain, so I might as well do business with you.’ He met his second wife Patricia at a bridge competition in New York. She agreed to marry him but only if he went and got a proper job, which had led him to the door of Bear Stearns.

Cayne was so close then to his new boss that he used to pick up Greenberg at his Fifth Avenue apartment every day and drive him in his Pontiac down Manhattan’s FDR Drive to the Bear Stearns office, then located at 55 Water Street. ‘It's like the Mafia, where the driver becomes the No. 2, except I insisted he sit in the front. He couldn't sit in the back.’

Cayne’s first major banking success came in the early 1970‘s. New York City’s finances were in a mess and the city was close to bankruptcy when clients came to Bear Stearns looking to unload their distressed New York City municipal bonds. Few other banks would touch the bonds but Cayne took a risk. He bought the bonds and was able to sell them on later at a good profit. Cayne went on to make a market for others in the bonds.

In 1978 Cayne joined the firms elite Executive Committee and when Bear Stearns was floated on the stock market in 1985, he became the firms sole President. When Greenberg moved on to become Chairman in July 1993, Cayne filled the vacant CEO slot with ease. On the day that Cayne took the CEO job, the BSC stock price was $16.61. His official company biography at the time included 10 lines about his achievements at Bear Stearns and 13 lines about his achievements as a bridge player, the latter of which included representing his country at the Bermuda Bowl, winning 13 national championships and being a Grand Life Master (the highest rank) of the American Contract Bridge League. One columnist went as far as describing Cayne as being an expert in ‘bridge financing‘.

Bear prospered in the 1990’s. One analyst said of Bears profits; ‘We haven't seen results this good since the miracle of the loaves and fishes.' Fortune Magazine ranked Bear Stearns as the best financial firm to work for. While equity markets stagnated at the start of the decade, the bond markers flourished, which Bear dominated. Cayne led effectively. He told The New York Times in 1993, whilst sitting at his desk surveying dealing screens, ‘We are hitting on all 99 cylinders. So you have to ask yourself, What can we do better? And I just can't decide what that might be. We are going to surprise some people this time around. I’ll tell you what worries me, that we might be doing something stupid.' Top executives and traders at Bear were well remunerated under Cayne. ‘My father was a patent attorney, and he never made more than 75 grand in his whole life. But if I don't pay my guy $1 million, nine of my competitors are willing to pay him four times that.’

Cayne played the hand he was dealt well, and not only at Bear. He played bridge after work at the Regency Whist Club on Manhattan's East Side with Greenberg, a Laurence Tisch of CBS, and a Milton Petrie of Petrie Stores. Star players such as Warren Buffett and Malcolm Forbes occasionally played on the same team as those four. Together they liked to call themselves Corporate America's Six Honchos. Or "CASH" for short.

Cayne also likes to play golf. For many years on a Thursday afternoon, he left the office early to go to the East 34th Street Heliport for a 17-minute $1,700 helicopter ride to the Hollywood Golf Club, in Deal, New Jersey. After spending the night at his nearby holiday home he would play golf again on Friday, Saturday and Sunday, with 8.00 am tee off times and then spend the rest of the weekend with his grandchildren or playing online poker. The Hollywood Golf Club prohibits the use of mobile telephones on the course so it was common on Fridays for Cayne to call in to the office from a land line at the 9^th tee.

Cayne can be blunt at times. An investment firm chief once brought her 11-year-old son to visit Bears office. She says that she introduced him to Cayne, who later pulled her aside and told her, ‘That kid's got a rotten handshake. He's going nowhere in life.’

Bear had begun life as a run of the mill conservative Wall Street brokerage, buying and selling securities, managing accounts for high net worth private clients and providing back office clearing services to hedge funds (known as prime brokerage). But Bear never achieved much of note in the world of equities, asset management or advisory work. Then in the first decade of the 21^st century, one of their business began to truly excel. Bear had a niche in issuing securitised bonds; debt securities secured on various receivables.

Issuing bonds secured on receivables is a logical development in the financing of many global companies. At any one time credit card companies such as MasterCard, VISA, MNBA and American Express have billions of receivables due from consumers but these companies would prefer to receive their cash now, rather than wait. Each individual credit card balance may be small, but they can be packaged up into multi-million buck bundles and sold to other investors. These bonds are secured in the sense that they are repaid from the money which consumers remit to their credit card company. This appeals to investors since if a company such as MasterCard or VISA collapses, the investor will be repaid.

The same principle applies to other forms of consumer debt such as mortgages or car loans. Banks offer mortgages but they wish to package up and sell on those mortgages in order to use the proceeds to provide more mortgages and to grow their business. Bear was one of the first to develop collateralised mortgage obligations, which became a vast and profitable pool of securities linked to mortgages and their repayment schedules. Car companies such as General Motors, Ford or Opel offer car finance to car buyers and they package up these loans into tradeable bonds. Bonds can, and have been, issued and secured on the most diverse of receivables. Bowie bonds actually exist and the interest payments and future repayments are secured on royalties from David Bowies music.

Those who work in investment banking coin their own specialist language so as to make the industry largely unintelligible to others. Consequently collateralised debt obligations become known as CDO’s and collateralised mortgage obligations are known as CMO‘s. Bear made money from underwriting the issuance of CDO‘s and CMO‘s by charging a fixed percentage of the size of the bond issue. Underwriting bonds is like insurance. If an investment bank fails to sell a bond issue to its clients or to other investors, then the bank agrees to buy up the remainder of the unsold bonds. This way the issuer is assured of receiving all of the proceeds of the bond issue. Underwriting bonds in a buoyant stock market is a sure thing, a one-way bet. It is like an insurance company insuring all of the motor cars in a country where no one ever crashes their car, nor has their car stolen.

Bear also made money from trading these bonds once they were issued. They made an official market and quoted bid and offer prices, with a profitable spread in between. In 2006, $316 billion in mortgage-related CDO’s were issued, about 77 percent more than the year before, according to the Securities Industry and Financial Markets Association. Being a market leader in the product, Bear had to hold positions in many secured bonds. With this growth in securitisation, Bear was transformed into a investment bank trading increasingly exotic complex illiquid secured bonds. It financed the billions of investments with cheap overnight money. Cayne said,‘I didn't stop it. I didn't rein in the leverage.’

Bankers talk about the concept of leverage while the rest of us refer to it as borrowing. It made sense for Bear to borrow as much money as cheaply as they could and to try to make a return in excess of the interest rate they were paying, while at the same risking as little of their own money as possible. But sometimes investments are long term and can’t be converted into cash quickly. The first sign of trouble at Bear came in June 2007.

The early warnings were in the US mortgage market. Home prices were falling, while delinquencies on loans to the weakest borrowers were on the increase. Simply put, home loans had been given to people over the years who should have never received a loan. These borrowers took out their loans at higher rates of interest because they had a higher likelihood of defaulting on their mortgage. They were below prime risk, or sub-prime.

Like much on Wall Street which is unnecessarily complicated, Bear formed two hedge funds with the grand names of the Bear Stearns High-Grade Structured Credit Strategies Fund and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund. The first fund was set up in 2003 and it was a winner from day one, managing 40 straight quarters of positive investment returns. But in 2006, when the returns fell and some investors began to ask for their money back, the second Enhanced Leverage fund was set up to take on bigger risks by using even more leverage. The ultimate size of the second fund was $6.6 billion, with $600 million of investors cash and $6 billion of borrowing, so for every dollar of cash received from investors, the fund borrowed $10.

Leverage can be fatal if not administered correctly. Imagine that all you own is $10,000 cash but someone will lend you up to ten times that amount so that you can play the stock market. So you do and all goes well and you make a 10% return in a year of $10,000, you pay back the loan and you double your wealth. But instead if markets fall 10%, your losses wipe out all your cash. You are bankrupt. It is game over in this zero-sum game.

As the value of most mortgage securities fell, so too did the value of the two funds. In mid 2007 the return of the second fund was so poor that some investors pulled their investments from the fund. Bear wrote to their clients in July to confirm that the two hedge funds now contain "very little" or "effectively no value" for investors. Bear announced that it would provide a line of credit of $3.2 billion to rescue one of the two highly leveraged mortgage-related hedge funds, which reported to Bears number two executive Warren Spector. And yes, Spector does play bridge, and rather well too.

Caynes major failing at this time was that he did not address this funds issue. He expected Spector to deal with the mess. So from 18th to 29th July Cayne went to play bridge at the North American Bridge Championship, this time in Nashville. He was amazed to meet Spector there playing at the same bridge competition, who was taking his first holiday of the year. In this critical month of July, Cayne spent 10 of the 21 workdays out of the office, either at the bridge event or golfing, according to golf, bridge and hotel records. For this specific achievement Cayne was ranked at number 30 in Fortune Magazines ‘101 Dumbest Moments in Business‘ survey, published in early 2008. Back at Bear on 30 July, Cayne belatedly convened a meeting of senior executives. Cayne asked Spector to resign. In the end Bear lent $1.6 billion to the first fund but it allowed the second fund to fail.

One top Bear trader wrote a personal blog where he described his job of unwinding the bonds in the funds as ‘trying to defend Sparta against the Persian hordes of Wall Street.’

The two former managers of the hedge funds were arrested to face criminal fraud charges. Like most arrests on Wall Street they were marched from a Brooklyn court in handcuffs by Federal agents and sat into the rear of cars where they could be photographed by all. In the spring of 2007 the two had exchanged emails,’ “I’m fearful of these markets,” one wrote. The other said later, “Believe it or not, I’ve been able to convince people to add more money.” He added more, to calm his colleague, ‘We are not 19 year olds in Iraq.’

Cayne was not a happy CEO at the time. ‘This is a body blow of massive proportion. I’m angry. When you walk around with the reputation for being the most rigorous risk analyzer, assessor, controller and that is trashed, well, you have got to feel bad. This is personal. There is a lot of pain here. I would have bet against this occurring at Bear Stearns. In the last 15 years, I have never walked into a room or been at a dinner party where I did not feel that when people looked at me they thought I was O.K., successful, agile. That might have changed. I feel like people now look at me with a question mark.’

Following such large and unexpected losses, Bear needed new capital, and soon. In an effort to save the bank, Cayne flew to Florida to meet Joe Lewis, a Bahamas-based billionaire commodities investor and Bear Stearns' brokerage client. Lewis invested after Cayne convinced him that Bear stock was a bargain. In September 2007, Lewis spent $864 million buying a 7% stake in the bank. The two also loved gin rummy. Lewis lost all of his investment but took it well. Cayne said of Lewis, ‘He's an adult, not a whiner.’

On the Labour Day weekend, Cayne took a secret trip to Beijing where he negotiated a $1 billion cross investment with Citic, China's largest investment bank. The deal involved Citic taking a stake of 6% in Bear which valued Caynes bank at $20 billion. The deal was announced afterwards, but the transaction took months to close, and it would be too late.

Cayne told an investor conference in October. ‘I'm confident that Bear Stearns will weather the storm and come out a stronger, more diversified and a greater organization.’ A reporter from CNBC asked him why he still came to work when he could sell his shares and retire any day? He replied, ‘If I'm going down, I'm going down like a samurai.’

Next the usually reliable Wall Street Journal reported that Cayne smoked marijuana at bridge tournaments, including once in Memphis in 2004, when a woman smoked a joint in the bathroom with him. He denied it. ‘This story about smoking marijuana with some woman in a bathroom at a tournament site is pure fiction.’ Cayne prefers to smoke $140 Montecristo cigars in his apartment in his study, which his wife calls the ‘womb room’.

In November Bear reported its first ever quarterly loss of $854 million, having written off $1.9 billion of mortgage-backed securities. No one wished to purchase these securities. Even their accurate valuation became a guessing game. When the mortgage-backed music stopped, there was no chair for Bear. ‘That was a period of not seeing the light at the end of the tunnel. It was not knowing what to do. It's not being able to make a definitive decision one way or the other because I just couldn't tell you what was going to happen.’ In January 2008 Cayne resigned as CEO but he remained on as non-executive Chairman.

In early 2008 liquidity became critical for Bear. The bank needed about $50 billion in overnight funding and all it could offer in return as security were mortgage-backed debt securities of an uncertain value. Other banks would not lend money to Bear and they began to recall their assets. These banks were no longer concerned with a return on cash. They were concerned with a return of cash. Confidence in Bear ebbed away and this time it would be fatal. The ‘run’ on the bank had begun. But in February Cayne and his wife purchased not one but two adjacent apartments for $28 million, on the 14th floor of the renovated Plaza Hotel at the corner of Fifth Avenue and 59th Street, complete with 6,000 square feet, room service, maid service, and unparalleled views of Central Park. Cayne reportedly paid cash for the apartment - he did not need to avail of a sub-prime mortgage.

The situation at Bear worsened significantly in March. On Monday 10th March the Bear stock price fell and CNBC reported ‘There are rumours out there that some unnamed Wall Street firm might be having liquidity problems.‘ Another TV pundit said, ‘The speculation at this point is that it is Bear Stearns. They’re down the most in the market today. Supposedly, a couple of weeks ago, they started looking at a way to try to shop their clearing operation. They couldn’t find a buyer. At least that’s what one guy says.’

Bear was forced to issue a public statement. "There is absolutely no truth to the rumours of liquidity problems that circulated today in the market." While the firm had some $17 billion in cash, Bear was still addicted to leverage, with $11 billion in tangible equity capital supporting $395 billion in assets, a high leverage ratio of more than 36 to one. Later on the 10^th March, another major bank declined to make a $2 billion securities-backed repurchase (or ‘repo‘) loan to Bear. It was a sign that credit was drying up. Being declined on a repo trade on Wall Street is like a friend refusing to lend you ten bucks.

On Tuesday 11th March, Bears Chief Financial Officer went on CNBC TV to say, ‘Why is this happening? If I knew why it was happening, I would do something to address it. There is no liquidity crisis. No margin calls. It's nonsense.’ Then Goldman Sachs sent its hedge fund clients an email to say, contrary to an earlier arrangement, that if Bear did not settle obligations on interest rate swaps, Goldman would no longer step in to protect its clients or offer novated Bear derivatives deals. Goldman were simply done with Bear.

On Wednesday 12^th March clients and hedge funds began to pull funds from Bear. This time the new CEO Alan Schwartz went on CNBC TV to counter the rumours. ‘We're not being made aware of anybody who is not taking our credit as a counterparty. We don't see any pressure on our liquidity, let alone a liquidity crisis.’ Schwartz spoke from the Bear Stearns Media Conference in sun-kissed Palm Beach, Florida. Many were unimpressed.

By Thursday 13^th March, Bears liquidity had fallen from $11 billion to $2 billion. A crisis board meeting was held by conference call in the evening. Cayne joined the call late and remotely because he was playing bridge at the North American Bridge Championships, in Detroit. He was hard to reach since he had only recently got a mobile phone and he had no Blackberry. Afterwards Schwartz contacted Jamie Dimon, CEO of JP Morgan Chase.

On Friday 14th March at 9 am the Federal Reserve Board and JP Morgan Chase provided $30 billion of funding to Bear while rating agencies downgraded Bear and the BSC stock price plunged to $32. Confidence in Bear as a going concern was gone. A lack of liquidity did not kill the Bear, rather it was a lack of that other essential quality in any bank - confidence. This becomes a self-fulfilling prophesy and the death spiral soon develops. The only remaining options were a bail-out by the government, a sale to another bank, or a bankruptcy / liquidation before the markets opened on the following Monday morning. Bear staff went to Maggie’s Bar on 47^th to down Bud long-necks amidst TV news crews.

Cayne wished to return to New York from Detroit immediately but he has a lifelong aversion to flying on commercial airlines. He once described his disinclination to travel for business matters, saying privately he wouldn't meet with President George Bush about economic issues unless the president came to Bear's New York offices. Not one to slum it ever in Business Class on Delta or Northwest he sought as was his preference a private jet to take him home. However this jet proved hard to find at short notice in Detroit and consequently Cayne did not return to New York City until Saturday night at 6.30 pm.

He went directly to the Bear office at 383 Madison Avenue.‘When I walked in they said, 'It's $8 to $12 a share. That's the deal with J.P. Morgan.’ JP Morgan Chase was poised to consummate a shot-gun marriage with Bear at a fire sale price, thereby acquiring Bear’s valuable prime broker division and its new $1.1 billion head office building on Madison & 47th. JP Morgan Chases offices are conveniently located directly across on 47th Street.

On the Sunday morning, while the JP Morgan deal was being inked, Cayne went out to breakfast at the Jackson Hole diner, at 91st Street and Madison Avenue, with Vincent Tese, the lead independent director on Bear's board. They spoke about the other option; bankruptcy. Cayne the card player referred to it as the ‘nuclear card’. ‘But you can't play it. You can't play it. If anybody on Earth would have played it, it would have been me."

Later the acquisition price fell to $5, then to $2, the price at which Cayne and the Bear board duly approved the deal on the Sunday evening. Cayne voted for the revised and improved $10-a-share deal one week later (after vocal protests to JP Morgan Chase by investors) and said, `Six million shares, I just got my butt kicked.' JP Morgan Chase finally acquired Bear Stearns on 30th March. ‘I felt nothing. You got a bad grade on your test. That's it. No appeal. I felt sad for me and sad for my Bear Stearns family.’

At the end Caynes instincts that had served him well for 15 years at Bear deserted him. As a lifelong salesman, trader and card player, he was not equipped for a credit crisis. ‘The options were limited. When you become roadkill, when you happen to have lost some weight and you're not really healthy, but you know one thing - you know that you have worked your ass off and you're not smart enough to know the answer - that's tough.’

On 25 March, Cayne sold his 5.66 million shares in the open market at a price of $10.84. He sold his shares via Bear Stearns. Greenberg could have charged him the staff discount commission of $2,500 but he charged Cayne the typical commission charged to clients of $77,000.‘If he doesn't like it, he should do his future business elsewhere’, said Greenberg, who told The New York Times, ‘He was a one man show. He didn’t listen to anyone.’ In the final years Cayne and Greenbergs rivalry had not diminished. Cayne always refused to call Greenberg "Ace" and he billed anyone who used the nickname in his presence $100.

The 85 year old bank, which had survived a depression and recessions was no more. After the watershed demise, t-shirts were sold outside the head office with the slogan ‘I worked for Bear Stearns 20 years and all I got was a Cayne-ing.’ The t-shirt portrayed a cartoon of Cayne standing on a putting green, playing a fiddle. Embarrassed staff left with their life’s work in white plastic Bear Stearns carrier bags. Other staff stuck a symbolic two dollar bill on the revolving doors, which this time were revolving in only one direction.

No one offered Cayne a new job at JP Morgan Chase. In contrast, Greenberg, at the ripe old age of 80, became the vice chairman emeritus of the two recently merged entities. The International Herald Tribune reported that Cayne, together with his wife, who is a student of Jewish religious traditions, spent considerable time searching for comparable events in religious history to see what lessons can be learned from the collapse of his firm. When Cayne finally left Bear he did what he knew and loved best. He went to play in a national bridge competition in Las Vegas where he gladly reached the semi-finals.

Cayne had often given advice to his colleagues at Bear: Hold on to your stock. Bear employees owned one third of the bank. Many had taken their annual bonus in the form of Bear shares and so they lost their life savings in the collapse. Cayne reportedly beefed up his personal security to protect him from any disgruntled employees. In contrast Cayne took home more than $232 million in salary, bonus and other pay between 1993 and 2006. He is now down to his last few hundred million bucks. ‘When you lose a billion but you still have several hundred million left, then it’s your heirs that get hurt, not you.’

Cayne’s final comments came at the Bear shareholder meeting in May to approve the JP Morgan Chase deal. ‘I just want to personally apologise for what has happened,’ Cayne said at the meeting which was held in a packed auditorium in Bears headquarters but which lasted in all less than ten minutes. ‘We just ran into our own hurricane.’

Outside the meeting at the bank, a caricature painting of Cayne entitled ’The Annotated Bear’ was on show. Some staff thought Cayne might like to buy the painting for his new $28 million apartment. ‘Who wants bare walls?’ they asked news reporters. The painting featured comments from employees with blunt messages for their long-time CEO and chairman. ‘Opening Bid: One Dimon,’ read one scribbled comment. Another comment was ’BSC RIP’. Someone wrote boldly, ‘Should have known when to fold ‘em, Jimmy.’