April 2, 2009
AND NOT A POWERFUL FORCE YOU'D WANT TO BET AGAINST:
Remember Bear Stearns?: Its failure marked the beginning of the financial crisis and still offers lessons for the future. (Daniel Gross, 4/02/09, Newsweek)
"House of Cards: A Tale of Hubris and Wretched Excess on Wall Street" provides a fly-on-the-wall view of the history of Bear and its ignominious end. [William D. Cohan] spoke with NEWSWEEK's Daniel Gross.There's a sense that at many firms, the top executives literally didn't understand some of the securities they were buying and selling, like CDOs. Was that true here?
Cayne tells me that he didn't understand the risk that was inherent in these securities and the business plan that Bear had adopted. I believe him, but it makes you scratch your head. He's getting paid $30 million a year, year after year, enjoying all the fruits of this risk-taking, but he now claims he doesn't understand how all that happened? Why did the board of directors of this company have somebody as a CEO who didn't understand this?
When two hedge funds managed by Bear Stearns blew up in the summer of 2007, it seems like Cayne's reaction was similar to the one he had when Long-Term Capital blew up in the late 1990s: to hell with our reputation, we're not going to bail other investors out.
In 2007, he was talking about bailing out the overnight lenders to the hedge funds. And he argued vociferously not to do it. He got overruled. Ace Greenberg basically insisted that their reputation was on the line. The problem was that when Bear liquidated the hedge fund, it took control of collateral that creditors had held. A lot of it was CDOs. And those securities quickly became almost worthless--causing the big write-off they had in the fourth quarter of 2007, which caused Bear to take the first loss in its history.
That would have seemed a logical time to take a step back and dial down the amount of leverage Bear was using. Did nobody internally stand up and say that in the summer or fall of 2007?
Ironically, the closest anybody came to doing that was Jimmy Cayne. He may not know why he didn't want to do it, but he got a gut reaction that it was too much to take on. And they had many opportunities starting in the summer of 2007 to raise capital, but never did. They only wanted to take new capital if they saw it had a strategic benefit. In March 2008, when they went under, they had $18 billion in cash, but every night they borrowed $75 billion from overnight lenders. It had to be renewed every day. And unfortunately it gave these overnight lenders a vote every night. It's like if you voted for President Obama every day, and one day you decide that you don't like him, and you vote him out of office. That's what happened to Bear.
Looking back, is Wall Street a better place or a worse place with Bear gone?
Well, it's certainly different. Bear's downfall was symptomatic of what happened on Wall Street, which rewarded this crazy behavior without having accountability whatsoever. There are no big independent investment banks anymore. The compensation has come way down. Will it return? Human nature is such a powerful force. A month after I came to Wall Street in 1987, there was a crash, and I saw grown men cry, vowing that they'd never repeat what had been done. Twenty-two years and five financial crises later, we're right back at it again.
We'll be back here again just as rhythmically.