House of Cards (26 page)

Customers and counterparties quickly reverted to the same strategy they had employed the previous Thursday and Friday: curtailing their trading and pulling their money out. “Over the course of the day our phone lines stopped ringing and no trades were being done,” a Bear executive said. Even Dimon realized the trouble wasn't over for Bear Stearns just because JPMorgan had guaranteed its trades. “Even after we bought it, even after we guaranteed globally some of the trading obligations, there was still a run on the bank,” he said. “We still had to put out billions of dollars on an unsecured basis to them.” Added Molinaro: “It's like the market didn't believe the merger.” In Washington, the White House team behind the deal was all smiles. President Bush invited Paulson, Bernanke, and Cox, among others of his economic brain trust, to a meeting in the Roosevelt Room. Bush praised Paulson particularly for showing “the country and the world that the United States is on top of the situation” and added, “I want to thank you, Mr. Secretary, for working over the weekend.” Bush added that his administration was committed to taking other steps, as needed, to reduce the financial crisis. “We obviously will
continue to monitor the situation and when need be, will act decisively, in a way that continues to bring order to the financial markets,” he said. Outside the White House, after the meetings, Paulson defended the decision to bail out the Bear Stearns debt holders and to sanction the $2 for shareholders. “This was an easy decision,” he said. “This is the right outcome. And again, in terms of moral hazard, look at what happened to the Bear Stearns shareholders.”

At some point on Monday, the lawyers on the deal began to realize there was a “serious wrinkle,” in Parr's words, about how the guarantee had been structured. “The problem was if our shareholders kept voting down the deal all the way for a year,” Parr explained, “at the end of a year we could get out of the deal and whatever guarantees were in place at that point in time remained in place. That was the critical issue.” Bear's shareholders began to figure out something that Cavanaugh, Black, and Winters had not understood during the previous night's conference call. The poorly drafted guarantee—in fairness, the time allotted to draft it was extremely circumscribed and the concept was somewhat novel— gave Bear's shareholders a free, one-year option to run the firm using JPMorgan's balance sheet. All they had to do was continuously vote down the deal for the next year. What's more, not only had JPMorgan agreed to guarantee all the trading and counterparty obligations, but it also had agreed to assume all of Bear's long-term debt at the time the deal closed. This got some clever people on Bear's side thinking that as long as shareholders voted down the deal and the firm continued to operate based on JPMorgan's credit, Bear Stearns could systematically replace its short-term financing with longer-term debt. In effect, the logic went, JPMorgan could be forced to finance Bear Stearns for a good long time whether the deal closed or not. “Jamie was really upset when he found out that he was locked up in the same jail he locked us up in for a year,” Salerno said.

There were at least two other counterintuitive aspects to the deal as well. Normally, in a newly announced merger, arbitrageurs rush in to buy the stock of the target company (while shorting the stock of the acquirer) and then begin to hope, lobby, or both that they can finagle a higher price. Usually, the deal dynamic is such that a small percentage increase in price—say, a move to $70 a share from $65 a share, to cite the case of InBev's 2008 acquisition of Anheuser-Busch—combined with a relatively quick resolution will yield a desirable annualized return. Everyone's happy and the deal gets done. In this case, a very different dynamic quickly became apparent. Since Bear Stearns's book value was $84 per share and the offer price was $2 a share, there was a sense in the market that the potential upside on pushing to recut the deal was huge, even if
the book value was discounted aggressively. The
Barron's
analysis helped to fuel this thinking among investors. Even if an arb bought the Bear stock at, say, $4 per share on Monday, if the deal were renegotiated to $6, the nominal return would be a whopping 50 percent and the annualized return would be even higher. On the other hand, the downside risk was minimal. If you were an existing stockholder and the stock went from $2 to zero, so what? The vast majority of the money had already been lost as the stock went from $172.69 to $2. The incentive was clear: there was far more to be gained for shareholders by voting down the deal each and every time for the next year knowing that JPMorgan remained on the hook for operating Bear's business. This was that rare instance where the arbs believed the magnitude of the potential upside more than offset the prospect of having “dead money”—money locked up in a deal earning no return. “Here it's easy to think you might get another 100 percent,” Parr said, “and for that matter, what do you have to lose between two and zero? Next to nothing. So the mind-set is different. The shareholder vote is entirely different under the Bear Stearns facts. The fact pattern is shareholders have all kinds of reasons to vote no. The year's time is not that big a deal when you're talking about the possibility, however remote it might be, of a double or a triple.” One arb told the
Wall Street Journal:
“If you're a shareholder, why not make some noise and see if JPMorgan raises its offer or roll the dice and take your risk in bankruptcy? They're stealing the company. What do you have to lose?”

Counterbalancing the impulse to vote down the deal was the equally unusual dynamic where the holders of Bear's $70 billion of debt—who stood to be bailed out at 100¢ on the dollar when the deal closed—were desperate for shareholders to approve the deal. The debt holders started buying the stock in droves, pushing its price up, to ensure they would be able to vote for the deal. For the debt holders, who had far more to lose than shareholders, a busted deal would be devastating.

The traditional M&A dynamic had been turned on its head. But the lawyers at Wachtell, Lipton—no doubt with the approval of their client, JPMorgan—had drafted the contracts anticipating a more typical response. “You come back to the shareholders,” Parr said. “If they understood all this dynamic, and even if they didn't understand the dynamic, they could say, ‘Wow, upside/downside. I go from two to zero or I could go from two to ten.' That dynamic is a no vote. The company's protected and there are these guarantees. So there are a lot of reasons to vote no, and that was the flaw. Fairly quickly at JPMorgan they realized, ‘Oh, it's not two versus zero. It's optionality to the upside by voting no.’”

This was a major mistake, for sure, but one that appeared to leave no
fingerprints. The JPMorgan executives on the Sunday night conference call gave no indication—publicly, at least—that there was any misunderstanding about how the guarantee was to work. They described it exactly as it was drafted. Regardless, once JPMorgan became aware of the drafting flaw, Dimon was quick to blame Wachtell. “They are a superb firm,” explained Rog Cohen, at Sullivan & Cromwell. “They had their best lawyers on it. Maybe if there's any criticism—and I'm not sure there is—they should have been more skeptical with what their client agreed to do. I think the real problem is people looked at this as a straight M&A deal, but they didn't think through perhaps everything that was relevant. People didn't really consider what would happen if you didn't get the vote, that that was a low likelihood, and how that interacted with the guarantee. Who knows? Victory has a thousand fathers and defeat is an orphan. But whatever was the cause, it was a real mistake, there's no question about it.” (Ed Herlihy, the lead partner on the deal at Wachtell, Lipton, did not return a phone call seeking a comment on how this happened.)

In retrospect, even though Dimon thought his law firm had screwed up, Schwartz wasn't so sure. He said that the offending language came about because Wachtell was trying to prevent a situation in which another bidder swooped onto the scene after the deal was announced, benefiting from the market-stabilizing risks JPMorgan had agreed to take. The worst thing, he said, would have been if JPMorgan suddenly found itself in a bidding war against, say, Bank of America, after JPMorgan's merger agreement had steadied the ship. That's why Wachtell wanted there to be a year where nothing could happen without JPMorgan's approval. What nobody had counted on was that the JPMorgan guarantee would not provide confidence to the market to keep doing business with Bear Stearns. “If B of A came along and thought it was worth $80,” explained someone familiar with Schwartz's thinking, “JPMorgan would be in a situation, unless they paid $81, that they were going to not get it. So let's say B of A is willing to go to $50, JPMorgan would have had to pay $51. So they took all the risk to get into an even-handed bidding contest. That's a disaster.”

Regardless of the debate, while the lawyers toiled away trying to repair the deal, the rank-and-file Bear Stearns employees no longer had a whole lot to do, and didn't even know if they would have jobs under the new regime. Paul Friedman wrote to David Rawlings, another senior managing director at the firm, on Monday night that the day had been “surreal.” “I came in and canceled everything on my calendar since none of the items were relevant any longer. None of what I do—business building, problem solving, customer interaction or any other part of a normal
day—exists any more. The transition planning—such as it will be in Fixed Income—hasn't started. So I wandered around all day. Probably more of the same tomorrow. Let's def catch up, if only to relieve my boredom.” Later that night, Friedman wrote his sister, trying to describe to her his emotional state. “To say the least, it has been a surreal week,” he wrote. “As recently as last Wednesday, I was eagerly approaching my 27th anniversary of being happily employed at the Bear and all was reasonably right in the world. Even if the financial world is a mess, we were doing great and were about to announce to the world how good our first quarter earnings were. By the end of Thursday night, after being a victim of a series of incredibly inaccurate but self-fulfilling rumors about our having a liquidity problem, there had been a run on the bank and we were bankrupt (although we managed to postpone the actual collapse until Friday). We ended up working all night Thursday (my first all-nighter since Colgate) and all weekend trying to save the place, only to have it end with our being mugged by JPMorgan on Sunday. They are the absolute worst merger partner for us since there is enormous overlap between the two firms and, as a result, probably 12,000 of our 15,000 employees will ultimately be fired. And an 85-year-old firm disappears in a blink of an eye. In many ways, it's been like watching a family member die in front of your eyes—except maybe 15,000 times worse. Moreover, since the press doesn't quite understand what happened, half of them keep saying we somehow deserved this, something that is truly saddening.

“A truly distressing statistic,” he continued, “is that between Thursday and today, the employees of Bear Stearns—who own 40% of the company's stock—lost a combined $4 billion of personal net worth. Many of my friends there thought that the way to truly achieve wealth was to keep every share ever awarded and use that as their retirement planning (did they never hear of Enron? Drexel Burnham?) and now they are wiped out. Fortunately for Susie and me, I never believed in combining job risk and net worth risk in the same company so, while my deferred compensation evaporated over the weekend, I've always sold any freely available Bear Stearns stock the instant I received it. So I have the luxury of not having to worry about money problems and we live to fight another day. Not so for many of my friends, particularly those in their 30's and 40's who were just starting to earn real money and got overextended.”

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n Tuesday morning, the reclusive Joe Lewis, Bear's second-largest shareholder, showed up in Jimmy Cayne's office. Lewis, who made his $3 billion fortune trading currencies, was the 368th wealthiest man in the world. (Some estimated his fortune at $5 billion.) Lewis had been buying Bear Stearns shares since the late summer of 2007. Cayne first met Lewis, a longtime brokerage client of the firm, in 2000 when he flew down to visit him at his massive Orlando, Florida, estate. They hit it off and spent five hours together, bonding over a shared love of gin rummy. Cayne said he never spoke with Lewis about making an investment in Bear Stearns. In September 2007, Lewis announced, in a filing with the SEC, that he had made the first of several purchases of Bear stock, spending $864 million for a 7 percent stake. He kept on buying right up until the end—including making a $31.4 million purchase on March 13, when the stock was trading at $55.13—until he had invested more than $1.26 billion in the stock. The day before he came to see Cayne, he gave a rare public statement to CNBC, saying of the JPMorgan deal for Bear Stearns: “I think it is a derisory offer and I don't think they'll get it.”