Investment banking is a peculiar business. It takes decades and, in some cases, over a century to build a market-leading operation, only to then watch as it fails in a matter of days. While overleverage is often the predicate, a loss of confidence is the exciting cause. It's like a roaring avalanche triggered by an otherwise benign disruption far down the mountain.
For those on Wall Street who had forgotten this lesson in the heady days of the housing bubble, the second week of March 2008 served as an unwelcome reminder. Over the course of seven days, the nation's fifth largest investment bank went from being profitable and seemingly overcapitalized, to being forcibly led to the auction block by its government overseers. Less than a week after trading for $65 per share, the 85-year-old investment bank Bear Stearns could garner no more than $2 from its across-the-street rival, JPMorgan Chase (NYSE:JPM). And even that was conditioned upon a generous loss-sharing agreement with the Federal Reserve -- though, to be fair, the price was posthumously increased to $10 a share to keep the peace.
What follows on this, the fifth anniversary of Bear's collapse, is a brief look at the six most important dates that led to the storied bank's downfall.
1993 -- "I'm going to be the last CEO of Bear Stearns"
While it's hard to know exactly what Jimmy Cayne, Bear's CEO until January of 2008, meant by those words, it isn't difficult to conclude that the public and humiliating failure of the bank wasn't it. The reason I picked 1993 as the first date related to Bear's downfall is because that was the year Cayne became CEO.
If there's any truth to the notion that the character and culture of an organization is set at the top, then Cayne's coronation was arguably the moment that sealed the Bear's fate. He could hardly have been more different from his predecessor, Alan "Ace" Greenberg, who was known as a democratic, humble, hard-charging, risk-obsessed, and penny-pinching leader.
By comparison, Cayne was known for leaving the office early on Thursday to catch a chartered helicopter ride to various golf courses, taking multiple extended vacations each year to compete in bridge tournaments, and habitually smoking marijuana -- yes, you read that right. But, worst of all, he purportedly had neither any interest in, nor knowledge of, risk management. And it was for this reason that Bear's real estate traders were able to accumulate nearly $50 billion in mortgage-related assets on the bank's balance sheet by the time the housing market began to hemorrhage.
July 2007 -- "This is a watershed day"
During the first quarter of 2007, the signs of a problem in the housing market started to reveal themselves. Housing prices started to decline, mortgage delinquencies accelerated, and the secondary market for anything but the highest-quality mortgages began to show signs of fatigue.
The first line of institutions to feel the effects were mortgage originators like New Century Financial and Countrywide Financial, which Bank of America (NYSE: BAC) regrettably acquired in 2008. On March 2, New Century announced that, "as a result of the Company's current constrained funding capacity, the Company has elected to cease accepting loan applications from prospective borrowers effective immediately while the Company seeks to obtain additional funding capacity."
These tremors subsequently triggered a series of events that culminated, for the time being, at least, in the bankruptcy of two Bear-managed hedge funds that specialized in mortgage-backed securities. And this was the "watershed" moment that Cayne related to Merrill Lynch's then-CEO Stanley O'Neal during a chance encounter at restaurant in late-July 2007.
Fourth Quarter of 2007 -- "You've got to step down"
The fourth quarter marked an ignominious occasion for those at the top of Bear, for it was the first quarter in the bank's 85-year history that it had recorded a loss. To make matters worse, an article published by the Wall Street Journal in early November publicly questioned Cayne's handling of the unfolding crisis:
As Bear's fund meltdown was helping spark this year's mortgage-market and credit convulsions, Mr. Cayne at times missed key events. At a tense August conference call with investors, he left after a few opening words and listeners didn't know when he returned. In summer weeks, he typically left the office on Thursday afternoon and spent Friday at his New Jersey golf club, out of touch for stretches, according to associates and golf records. In the critical month of July, he spent 10 of the 21 workdays out of the office, either at the bridge event or golfing, according to golf, bridge and hotel records.
And, with regard to his reputation for smoking marijuana, which Cayne denies:
Mr. Cayne, who has also used bridge to help recruit clients, considers tournaments a welcome break, say people who've spent time with him at the events. He has played in at least three so far this year, staying from a few days to over a week at each.
Attendees say Mr. Cayne has sometimes smoked marijuana at the end of the day during bridge tournaments. He also has used pot in more private settings, according to people who say they witnessed him doing so or participated with him.
After a day of bridge at a Doubletree hotel in Memphis, in 2004, Mr. Cayne invited a fellow player and a woman to smoke pot with him, according to someone who was there, and led the two to a lobby men's room where he intended to light up. The other player declined, says the person who was there, but the woman followed Mr. Cayne inside and shared a joint, to the amusement of a passerby.
At the end of the day, the portrayal of his personal and professional habits by the Wall Street Journal, and the bank's fourth-quarter performance, were too much for even a storied veteran like Cayne to survive. It was left to his subordinate and successor, Alan Schwartz, to deliver the news that is was time to "step down."
March 10, 2008 -- "We have a serious problem"
After nearly two months at the helm, Schwartz had barely had time to settle into his new corner office before the immediate series of events leading to Bear's demise got under way. Two events on the morning of March 10, 2008 -- a Monday -- served to trigger a run on Bear's funding sources. First, the Federal Reserve launched a $50-billion lending facility intended to support financial institutions in trouble. And second, a major rating agency downgraded a swath of mortgage-backed securities issued by Bear.
As Kate Kelly recounts in her excellent book Street Fighters, "investors seemed to be interpreting the Fed's move as an attempted bailout of Bear, and the rating change on the securities as a downgrade of the firm itself." Over the course of the next four days, Bear's bread-and-butter hedge-fund clients furiously pulled their deposits out of the bank's prime brokerage unit, leaving Bear without the necessary liquidity to survive. And the rest, as they say, is history.
March 16th -- "You need to have a deal done by Sunday night"
By Friday, the Federal Reserve stepped in to provide a bridge loan, through JPMorgan, to ensure that Bear could make it to the weekend. But while Bear's executives had originally interpreted the deal to include financing for up to a month, they soon learned otherwise. During a late-night conversation with Hank Paulson, the then-Secretary of the Treasury informed Schwartz that a deal had to be completed before the markets opened on Monday. And by hook or by crook, a deal was done. By Sunday night, with an additional nudge by the Federal Reserve, Bear's board of directors agreed to sell the bank to JPMorgan for a mere $2 a share.
The Foolish bottom line
While the price was subsequently negotiated up to $10 a share, the Bear Stearns' story serves as a valuable reminder to anyone in finance to avoid complacency. While the pieces of the bank's downfall were arguably put into place in 1993, the actual collapse occurred over the course of a single week. On this, the fifth anniversary of its downfall, here's to hoping we don't see another one of these for at least a generation.