Yesterday, Congress resumed their investigations of Wall Street and the financial crisis. It was Bear Stearn's turn on the hot seat as five former employees including Jimmy Cayne, the Chairman and CEO and Alan Schwartz the CEO for the last two months of the firm's life. Jimmy Cayne was not a man of many words when responding to the questions thrown at him. It may have appeared to be short and direct responses, which they were, but the man is not capable of being eloquent in public. Speaking was not his strength. In fact, his true strengths were probably selling municipal bonds and playing bridge. As a former member of the Bear family, we could never understand how Mr Cayne was elevated to the top of a major Wall Street firm during a time where financial instruments became much more sophisticated and complex. Of course to be a world class bridge player, he must be smart but that doesn't mean he was capable of managing a global financial empire.
Bear Stearns came crumbling down as it was clearly caught up in the housing collapse. Its history of strong risk management remained a focus within the firm but under Jimmy's leadership, attention to detail waned from the days of Ace Greenberg. Ace lived and died the firm and was always present. On the day before a holiday, one could always find Ace roaming the trading floors at 4pm to keep all the traders and salespeople on their toes. In 14 years at the firm, we never saw Jimmy Cayne once mingle with employees except at a cocktail party after the monthly Senior Managing Director meeting. Jimmy Cayne was arrogant and ran the business his way. The best managers are those who hire smarter people than themselves and expect them to bring fresh ideas and challenge the current operating procedures when necessary.
Jimmy Cayne had his small Executive Committee that raped the firm and its shareholders. Warren Spector and Alan Schwartz were certainly deserving of some big pay days. However, there wasn't an employee in the firm who could ever justify why Jimmy got paid the enormous sums year after year. The only bigger sin was paying the weakest CFO on Wall Street the highest compensation of any public firm's Chief Financial Officer. Sam was Jimmy's boy but it is hard to go from an average public accountant (maybe a good one) to CFO unless you have some great risk management skills and an ability to influence the firm's decisions. Sam did what Jimmy wanted and unfortunately, most Senior Managing Directors didn't believe Sam or Jimmy had a strong understanding of the complex nature of this global franchise.
For years, Jimmy Cayne either pushed out highly qualified employees as they gained power or refused to adequately compensate very skilled managers who in turn left the firm. The executive committee and their rich pay packages needed to be spread around to many talented people who eventually left Bear Stearns. It is ironic that two very senior people, who Jimmy Cayne refused to give more authority and power, left to become very very senior Partners at Goldman Sachs. This was Jimmy's way.
Congress asked Jimmy Cayne what he would have changed in his business model if he could do it all over again? Would it be the equity base, the leverage, and/or the short-term funding. The answer should have been all three. Jimmy said in retrospect maybe the leverage was too high. He couldn't answer the short-term funding as he probably didn't truly understand that much of the 1-day Repo loans were secured by longer-term assets. If one loses the short-term funding and the assets can't be sold in a day, a liquidity squeeze occurs, especially if the leverage is too high. My Cayne said he never would have issued equity as it was too cheap and he would have had to sell a big piece of the firm to do so.
Let's go back to September 2007. There were rumors that Bear was working on a partnership with a Chinese bank. We had a pretty good understanding of Bear Stearns at the time and began to feel uncomfortable with its financial position. The collapse of the two Bear Mortgage Hedge Funds put added pressure on the firm's balance sheet. It was very clear that the firm needed a big equity infusion or sell itself. A Chinese partnership could fill that need. My Cayne scurried to Asia over Labor Day weekend to ink a deal with CITIC and shortly afterward it was announced with many cheers. There were two problems with this deal. The first was that the details were never worked out and it was never signed. The second problem was that as proposed, the structure didn't result in Bear receiving additional cash to lower its leverage. The Chinese Bank/Securities Firm was going to invest $1 billion in Bear (hardly enough) and Bear was going to invest a like amount in the Chinese firm. Hence, no new cash and one of the dumbest deals of all time. Jimmy Cayne must have thought the investment community would perceive this new partnership as Bear's savior when in fact it was all smoke and mirrors. At the time, we assumed some other deal must be in the works.
The firm needed equity desperately but Jimmy Cayne, who owned about $1 billion of Bear stock, always thought the stock was worth more than it was. Apparently, some private equity firms saw value in Bear but no deal was good enough for Bear under Jimmy Cayne's watch. He is a master bridge player and the sale of Bear and some inflated price was always going to be his last trick. He was smarter than the rest of the world until he wasn't.
The questioning yesterday also addressed the difference in mortgage assets at other investment banks. Jimmy Cayne said the firm couldn't know others risk and there was no way for Bear to have seen the crisis coming. He said 99% of the financial community missed it. That may be so but 99% of the investment world didn't have a leading and dominant position in the mortgage market. As the leader of the firm, Jimmy Cayne should have asked more questions and Sam Molinaro should have been on top of the intricacies of the increasing defaults of the underlying mortgages as was Daved Viniar at Goldman Sachs. Since 2006, the unknown Hedge Fund manager named John Paulson, was scurrying to raise money specifically to short the mortgage market. John Paulson was not unknown to Bear Stearns as he was a former employee, a prime brokerage client, and a trading customer. The arrogance of Bear and of Jimmy Cayne cost employees and former employees billions of net worth. Good due diligence and strong risk management may have pushed Bear to understand why John Paulson had a different opinion than they did. The firm didn't have a leader in the mold of Ace Greenberg but instead this self-centered CEO ran the firm his way.
Leverage was high and the equity was always too cheap to sell. So when the perfect storm hit, this beloved firm evaporated over night. Better management could have changed history.
