House of Cards (4 page)

The Fed's capital injections and the rapid and high-profile meltdown of the Carlyle hedge fund did little to stem the growing concern about Bear Stearns and may even have fueled additional liquidity issues. On Yahoo, “elrrambu” announced on the afternoon of March 7 that he had bought Bear Stearns “puts,” an option to sell the stock at a certain price before a certain time and a reflection of increasingly negative sentiment. “Even Fed action this morning could [not] stop this pig from dying,” he wrote. A few minutes later, another observer agreed. “Bear is ready to rip,” he wrote, “just watch. Yeah, just wait till March 20 earnings announcement day. Only it should be called losses announcement day. It will rip all right. Like in r.i.p.—rest in peace. Bear has no business happening these days. They might just as well close the shop.” Added another bear on Bear: “It is SO f#@king over for BSC!!” That same Friday night, a “major bank” denied the firm's request to provide $2 billion in short-term financing. “Being denied such a loan is the Wall Street equivalent of having your buddy refuse to front you $5 the day before payday,”
Fortune
's Boyd wrote later. “Bear executives scrambled and raised the money elsewhere. But the sign was unmistakable: Credit was drying up.”

Boyd worked hard that night and over the weekend trying to figure out which bank—said to be European—had decided it would no longer be a counterparty to Bear Stearns in the overnight financing markets. Obviously, this would be a huge negative development for the firm and sad confirmation of what Marano feared. It would also be a big story for Boyd. “At that point, I'm pulling my fucking hair out—pardon my language— calling everybody,” he said. “I'm calling Deutsche Bank, I'm calling UBS, and I'm very aggressive. ‘Get your senior guys on the phone. Get your financing desk on the phone.' I don't want to talk to some stupid flack. I spent eight years on a desk. I'm smarter than all those flacks. They're all Kool-Aid drinkers. They don't honestly know a derivative from a bond from a stock. None of them are going to be able to ask their financing desk. They don't even know enough to call the repo guys on the financing desk. I told them, ‘Get your financing guys or get your credit guys on the phone with me, or you're going in
Fortune
.' Here's the
New York Post
coming out of me. I said, ‘There's two ways this is going to work: bad or good. This hand is good; this hand is bad. I shake your hand or I punch you. Let me know.’”

He talked to the traders on the repo desks at both UBS and Deutsche Bank, with a special focus on Deutsche because it had displayed an increasing ability to act like an American firm in its willingness to trade for
its own account. “I'm talking to the guys in New York, and they're saying, ‘We swear to Christ we are not the ones to have done that.' If Deutsche Bank had done it, I'm thinking, ‘Okay, that's the story right there.' The minute a repo line gets pulled, you die, okay? They die a terrible death.” But Boyd could never nail down which European bank had pulled Bear's line of credit.

A cover story in
Barron's
that appeared on Saturday, “Is Fannie Mae the Next Government Bailout?” served as a coda for all the growing speculation about just how bad things were looking in the housing market. “It's perhaps the cruelest of ironies that in the U.S. housing market's greatest hour of need, the major entity created during the Depression to bring liquidity to housing, Fannie Mae, may itself soon be in need of bailout,” Jonathan Laing wrote. He offered a cogent and prescient argument about the extent of Fannie's potential troubles given its increasing cost of borrowing, the rising cost of its credit default swaps, and the huge amount of subprime and Alt-A mortgages it had on its books. Nowhere did Laing mention the words “Bear Stearns,” but there was no question in the minds of many savvy readers—including some Bear Stearns senior executives—that if Fannie Mae was in trouble, Bear Stearns could be in trouble for the very same reasons. “I can't remember if [the
Barron's
article] contained a specific reference to Bear,” recalled one senior managing director, “but the ensuing belief that a Fannie Mae insolvency was coming and that it would be devastating to Bear was one of the things that started that horrible week of speculation.”

If any of this speculation about Bear Stearns's future—either real or perceived—bothered Alan D. Schwartz, the firm's fifty-seven-year-old CEO, he did not give even the slightest hint of it. After thirty-three years at Bear Stearns, Schwartz, a well-regarded media banker and Bear's longtime head of investment banking, had reluctantly taken the reins of the firm from the legendary Jimmy Cayne on January 8 after Bear's board accepted Cayne's resignation in the wake of the firm's first quarterly loss in its eighty-five-year history. When Schwartz announced Cayne's resignation at a breakfast meeting with the top leaders of the firm, he not only spoke about Cayne's contributions to the firm over the years—“Jimmy's legacy will be this wonderful building that we're all in,” Schwartz said finally, leaving some attendees scratching their heads—but also urged everyone to keep focused on doing business and not on the ongoing chatter about the firm. “‘You have to stop,’” Paul Friedman remembered Schwartz saying at that meeting. “‘You can't be influenced by stock price. You can't be influenced by our credit default spreads. Those are determined by people on the outside. They don't know what's really going on here. They
don't know that we have a vibrant franchise. You can't have your mental state be governed by what they say. You need to put your head down and work and go about your day, and ignore the stock price as best you can.' Which is easy to say unless you have your entire net worth wrapped up in it. I mean, it's the right line for the CEO to say. It makes sense conceptually. What could he say—‘Hey, I know we're all going bankrupt here'? There was nothing more he could do other than that.”

On Thursday, March 6, Schwartz flew down to Palm Beach a few days in advance of the firm's twenty-first annual four-day media conference, which was to begin at the luxurious Breakers Hotel on March 9. The night he arrived, he spoke to the board of Verizon Communications, the giant telecommunications company, about the state of the telecommunications industry. He spent much of the next two days playing golf on the sumptuous Ocean Course that surrounds the hotel. Very few of Bear's rank-and-file had any idea Schwartz was in Florida.

The turnout at the media conference was always stellar, with the likes of Sumner Redstone, chairman of the board of both Viacom and CBS; Robert Iger, chairman and CEO of Disney; and Jeffrey Zucker, the president and CEO of NBC Universal. The year before, Schwartz had made a point of telling the audience that Bear's media conference was the only one he participated in, which made sense given the other demands on his time and the chance it afforded him to hobnob in a relaxed and luxurious setting with his media clients.

During the 2008 conference, Schwartz and Redstone got to talking about how Redstone had stayed so physically and professionally active at nearly eighty-five years old. Redstone mentioned how he exercises seventy minutes a day and eats and drinks “every antioxidant known to man.” Schwartz then asked Redstone what advice he could give about developing and maintaining a long and active professional career. “I don't think you begin by thinking about your career,” Redstone said. “You take each step at a time, recognizing that opportunity never knocks. You have to go look for it, and I've looked for it all my life. I enjoy my life because I love what I do. I have a passion to win, as you know. You don't always win, but you need to have that passion and, most important, you have to be able to look ahead.”

While Schwartz was roaming around the Breakers and waxing philosophical with his clients, back in New York the concerns about Bear Stearns's liquidity were intensifying. The firm's stock fell 11 percent on Monday morning, March 10, to its lowest level in five years, after Moody's, one of the three independent ratings agencies, downgraded portions of fifteen mortgage bonds underwritten by the firm, including the Alt-A securities,
and suggested that further ratings cuts in these mortgage securities would be likely. Moody's said the downgrades were based on “higher-than-anticipated rates of delinquency” and “foreclosure … in the underlying collateral relative to credit enhancement levels.” The Rabobank Group, a Dutch bank, told the firm before noon that it would not roll over a $500 million loan coming due later in the week and it was unlikely to renew a $2 billion line of credit coming due the following week. “Though Bear Stearns's overall financing from other banks totaled $119 billion, the Rabobank decision signaled that lenders were getting antsy,” the
Wall Street Journal
reported.

With Schwartz down in Palm Beach and Cayne “retired”—though still chairman of the board of directors—and playing bridge at the North American championships in Detroit, it fell to Alan “Ace” Greenberg, the eighty-one-year-old former Bear chairman and CEO (and still chairman of the executive committee), to try to calm the roiling markets. He told CNBC at around lunchtime that the liquidity concerns about the company were absurd. “It's ridiculous, totally ridiculous,” he said in a brief telephone interview from his desk with Michelle Caruso-Cabrera at CNBC, who called him out of the blue. Greenberg prided himself on answering his own phone without screening and on saying what was on his mind. This time his partners cringed. “Just another Ace-ism,” one of the more sympathetic executives called it. The firm then put out a statement denying “market rumors regarding the firm's liquidity” and adding that “there is absolutely no truth to the rumors of liquidity problems that circulated today in the market.” The release included a quotation from Schwartz: “Bear Stearns' balance sheet, liquidity and capital remain strong.”

CNBC Wall Street reporter David Faber described these public statements of denial as wholly “atypical” for Wall Street executives. “No firm is going to say it's having trouble with liquidity, and in fact you've either got liquidity or you don't,” he said on air at around two o'clock in the afternoon. “So if you don't have it, you're done. But these are the kinds of concerns in this market—concerns of confidence that people need to be aware of, because we are in a very difficult market where credit continues to be the driving concern and you can have a crisis of confidence, causing a meltdown.”

Wall Street operates on trust, and in a world of instant communication that trust can be eroded instantly. The old saw “It takes a lifetime to build a reputation—and a moment to destroy it” is as true as ever in financial markets. Sometimes even the truth cannot act as a tourniquet to stanch the bleeding. “We are now pretending our entire economic system
is sound,” wrote Michael Shedlock, a blogger and an investment advisor at Sitka Pacific Capital Management, in Edmonds, Washington, on March 10. “Clearly it's not.”

Next came the massive jolt the rumor mill received on Monday as word began seeping into the market that a federal regulator—believed to be the Office of the Comptroller of the Currency, a relatively obscure federal agency responsible for chartering and supervising all national banks—began making pointed calls to the banks it supervises asking them directly and specifically about their exposure to Bear Stearns. The calls were not about their exposure to a group of banks, Bear Stearns among them, but rather solely about Bear Stearns. There was no question that by the beginning of March, John C. Dugan, the comptroller of the currency, was plenty worried about the financial condition of the banks he regulated. “In general, due to a long period of strong economic growth, exceptionally low credit losses, and strong capital ratios, the national banking system has been healthy and vibrant,” he testified before the Senate Committee on Banking, Housing, and Urban Affairs on March 4. “Now, however, the system is being tested. Two powerful and related forces are exerting real stress on banks of all sizes and in many different parts of the country. One is the large and unprecedented series of credit market disruptions, still unfolding, that was precipitated by declining house prices and severe problems with subprime mortgages. The other is the slowdown in the economy, which has begun to generate a noticeable decline in credit quality in a number of asset classes. The combination of these forces has strained the resources of many of the national banks we regulate.” Whether Dugan's office made these calls or not—and a spokesman from the comptroller's office, Dean DeBuck, had “no comment” but did not expressly deny that the calls had been made— the tempest that raged as a result of the presumption that they were made was of historic proportions. There were indications on March 10 that Bear Stearns might no longer be able to control its own fate. The firm's public statements that day had the counterintuitive effect of fueling the market rumors rather than removing the oxygen from them.

The number of put options sold on Monday—short-term bets made by investors that Bear's stock would decline quickly—rose to 158,599, some seven times the twenty-day average, with the bets that the stock would fall outnumbering by 2.6 times those that it would rise.

More startling, though, was what bets investors were actually making. The most active contract sold on March 10 gave investors the right but not the obligation to sell Bear Stearns stock for $30 a share anytime before the options expired on March 21, in eight trading days. In other
words, for the buyers of these puts to make money, Bear's stock, which closed at $62.30 on Monday, would have to fall a stunning 52 percent in eight sessions.

Equally as startling as these bets was the fact that some investors wanted to make even more of them. On and around March 10, requests poured into the Chicago Board of Options to open up additional put opportunities for Bear Stearns. The CBOE, where options are traded, has guidelines to determine when to open up a series of options and usually avoids doing so if the strike price is either way in or way out of the money. But in this case, investors demanded that the CBOE make available a new March series of puts with an exercise price of $25 per share—a bet that the price of Bear's stock would fall below $25 in seven trading sessions—and a new April series with strike prices of $20 and $22.50. The CBOE agreed to accommodate the demand and opened up the new options for trading the next day, but will not say who asked that the new series be opened. These were major negative bets on Bear's short-and immediate-term prospects. Where were these large and seemingly highly improbable bets coming from? Nobody seemed to know for sure.