House of Cards (15 page)

Inside Bear, the news about the Fed facility was announced around the firm. “We went out and we announced it to the trading floor,” Friedman said. “I got high-fives. Oh, man, we were doing a victory lap. One of the salespeople made the comment, ‘We're now a sovereign credit. All those people who wouldn't deal with us, we're now a sovereign credit.' That was the line. Oh, man. We thought this was great. Somebody put out on their Bloomberg message, ‘We've got money to lend at Libor less 50,' because we got access to all the cheapest money in the world. All we need.”

Initially, Bear Stearns stock rallied on the news by about 10 percent, to around $64 a share, but about a half hour later, while everyone was still scrambling to figure out the repercussions of the Fed's move, the stock started to fall. “Initial reaction seemed to be very positive,” Molinaro said. “Why it went south I don't know. I can tell you I had analysts calling me on Friday morning. They couldn't figure out why the stock was getting pummeled this way, because they were saying, ‘I don't get it. It seems like a good thing. Why is the market reacting like this? It seems like a good thing.’” Friedman added, “You couldn't answer the phone fast enough of people wanting their money out.”

Even though there were virtually no details of how the JPMorgan loan would work, the market was quickly forming the view that the very fact that the Fed had had to step in and arrange for this facility meant that the situation at Bear Stearns was tenuous at best. By 10:15, Bear Stearns stock had erased all of its earlier gains and was now trading at around $30 per share, down close to 50 percent. The Federal Reserve Board then put out a statement, which was a paragon of banality: “The Federal Reserve is monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system. The Board voted unanimously to approve the arrangement announced by JPMorgan Chase and Bear Stearns this morning.”

A friend of Friedman's from Barclays Capital, Peter Glinert, wrote and asked him how he was holding up. “I was here all night working in this JPM thing,” Friedman responded. “Running on fumes right now. Didn't expect this horrible reaction.”

His friend wrote back that the “perception is [JPMorgan] are going to cherry pick a few divisions, and let the rest of [Bear Stearns] go under. It seems to me wrong, but [the] market is killing it.”

Responded Friedman: “Killing it is an understatement.”

“Why JP?” Glinert asked. “Seems to me they are tapping the window for you.”

“Had no time,” Friedman responded. “Needed someone in NY with lots of money and without their own problems. Pretty much ruled out Citi. Also, JPM had the most exposure to us and the most to lose. Didn't expect them to strongarm the Fed into taking the risk and making it a bailout.”

“Someone has to stabilize the stock now or [those actions] will be irrelevant,” Gilnert observed.

“Agreed,” Friedman wrote. “Didn't expect this insane response to it but I guess I should have. But when they write the book on this one I can say, ‘I was there.’”

Fifteen minutes later, Schwartz broadcast a video message to the firm's employees telling them he was disappointed in the events of recent days and urging them not to lose faith. Asked by a reporter how he felt, Ace Greenberg said, “I feel fine,” but declined to answer more questions.

Coincidentally, at 11:20
A.M.
, President Bush appeared before the Economic Club of New York to speak about the economy. To laughter, President Bush opened his remarks with the observation, “It seems like I showed up in an interesting moment during an interesting time.” His speech focused on whether a recession was looming and the steps the government had taken in trying to avert an economic crisis. He spoke briefly about the efforts by the Federal Reserve during the course of the week to pump additional liquidity into the financial system. “This week the Fed also announced a major move to ease stress in the credit markets by adding liquidity,” he said. “It was strong action by the Fed.”

The president's speech, while upbeat and not without its touches of humor, did little to assuage the market's concerns about Bear Stearns. That responsibility, as it should, fell to the top Bear executives, Alan Schwartz, the CEO, and Sam Molinaro, the CFO and chief operating officer. A conference call, hastily arranged for 12:30
P.M.
, was designed “to address speculation in the marketplace.” Neither Schwartz nor Molinaro had left the firm's office in the last twenty-four hours.

There is no question that both Schwartz and Molinaro believed that the situation, while still dire, was no longer as cataclysmic as it had seemed just twelve hours earlier. Molinaro began by stating that the firm had decided to push up to Monday the announcement of its first-quarter
financial results. Clearly this was an effort to calm the market down and to convey that, as Schwartz had said on Wednesday, he remained “comfortable” with the range of analysts' estimates about the company's performance, all of which projected that the firm would be profitable again.

Schwartz then spoke about Bear's financial hurricane. “As we said in our release, Bear Stearns has been subject to a significant amount of rumor and innuendo over the past week. We attempted to try to provide some facts to the situation, but in the market environment we are in, the rumors intensified, and given the nervousness in the market, a lot of people, it seemed, wanted to act to protect themselves from the possibility of rumors being true and could wait later to see the facts.” He noted that while Bear's capital ratios remained in good shape, and the company had started the week with good liquidity, “the concerns on the part of counterparties, on the part of our customers and lenders, got to the point where a lot of people wanted to get cash out. We were responsibly trying to deal with those needs, and we were meeting those needs in every case, but they accelerated yesterday, especially late in the day. As we got through today, we recognized that, at the pace things were going, there could be continued liquidity demands that would outstrip our liquidity resources. In light of that, we felt like we needed to move quickly to allow us time to conduct normal operations and calm things down and allow us time to get some more facts out into the marketplace and have people get a chance to assess them.”

The question lingered in the air about whether the firm was simply in the eye of the storm. Schwartz explained that Bear had been working with Lazard to arrange the facility with JPMorgan, which he hoped “will allow us to achieve the objective of calming down the marketplace and giving us the chance to get some facts out into the marketplace.” Schwartz said Bear would continue working with Lazard on “alternatives”—often banker code for pursuing a sale of the company—“with a focus on ensuring that we can handle and protect our customers well and at the same time maximize shareholder value.” Schwartz then opened up the call to questions and said he looked forward to speaking with everyone again on Monday for the earnings release.

Guy Moszkowski, Merrill Lynch's Wall Street research analyst, asked the executives to explain, if they could, what had led to the liquidity crunch. Was it the failure of overnight lenders in the repo market to offer financing, the withdrawal by hedge funds of the free cash balances from their accounts, or both? Molinaro responded: “I would say that it's really a combination thereof.”

There was also the not unexpected question, asked by Nick Elfner,
at Wellington Management, about whether Schwartz could share more information about the new credit facility and how it would work. Without getting into the details—probably because he did not know himself— Schwartz tried to provide assurance that the new financing would allow the firm to continue to operate as close to normally as possible. “The facility that we have basically is lending against a lot of collateral that we have, and essentially provides all of the liquidity we're going to need to maintain a regular course of business,” he answered. “We just want to make this point: The reason—one of the reasons, amongst others— that we went to JPMorgan, after thinking about our alternatives, was that JPMorgan is a clearing agent for our collateral. Therefore, it was easy for them to see the kind and quality of the collateral that we had available and therefore could move very, very quickly.” Molinaro elaborated briefly that the new financing would allow Bear Stearns to pledge its collateral and borrow against it. “That is what was really causing the difficulty,” he said.

Before the call ended, Schwartz said he was confident the credit facility would calm down the marketplace and allow Bear Stearns to fashion a more permanent solution. “I think [with] the terms and size, we will be able to convince customers and counterparties that we have the ability to fund ourselves every day, to do business as usual,” he concluded. “But I think, frankly, what this is, is a bridge to a more permanent solution.”

Even before Schwartz could finish the conference call, the pundits over at CNBC were questioning whether the firm would survive until Monday. Bob Pisani repeatedly called the firm a “house of mirrors.” Dave Faber spoke about the Fed facility being a “short-term fix that doesn't deal with long-term confidence” and said the Fed had been trying to “forestall a massive run on the bank.” He added, ominously, that “typically a run on the bank becomes a self-fulfilling prophecy.” Steve Liesman blamed Bear Stearns for not doing “enough to plan for the worst-case scenario” during the nine months since the credit crisis had first taken hold. In his daily afternoon commentary, Faber continued his trenchant analysis: “Bear Stearns finds itself in a difficult position, having failed to stem the crisis of confidence that engulfed the firm this week.” He predicted that a “sale of the company” as “soon as Monday” seems “most likely,” with JPMorgan being the “leading” candidate. He closed with the tantalizing thought from “one of my sources” that with Bear's tangible book value at around $75 per share and the stock then trading around $30 a share, a deal for the firm “will be the greatest financial services deal for the buyer ever done.” The
Financial Times
called the Fed's rescue of Bear nothing less than “the final humiliation in a nine-month fall from
grace that has humbled one of Wall Street's toughest fighters,” Jimmy Cayne. “The rescue is galling for the cigar-smoking 74 year old, who personified Bear Stearns' reputation as Wall Street's scrappy underdog whose continued survival as an independent defied persistent predictions of its demise.”

Along with the ruminations going on over at CNBC and the
Financial Times
about Bear Stearns, there were two other public blows about to descend on the firm. First, just after Schwartz's conference call was ending, Meredith Whitney, the Oppenheimer research analyst, decided she could hold back no longer and downgraded Bear Stearns's stock to “underperform,” her firm's sell rating. She had just landed in London and had missed the conference call, but her associate told her about the Fed's action, which she considered to be of little significance, especially since details about the JPMorgan facility were still sparse. “The problem that Bear Stearns and other financials face is a great unwind of leverage,” she wrote. “A company is only as solvent as the perception of its solvency. When a company that is leveraged over 30-to-1”—and here she was being kind, since Bear's leverage was often as high as 50:1 during a given quarter—“faces a crisis of liquidity and confidence of creditworthiness, that company will be unable to leverage its collateral and its leverage will be forced down to 1-to-l. [Bear Stearns's] equity could become worthless as forced sales create asset deflation, which could cause cannibalization of remaining capital. We are in a tenuous market environment and experiencing a true crisis of confidence. The Fed's action in providing JPMorgan access to funding essentially buys time for Bear's counter-parties to unwind their position and deliver. The great unwind of leverage that will occur will further depress the stock prices of financials.”

Given all that was occurring that afternoon, Whitney's downgrade received little attention, even though she said the stock, which ended the day around $30 a share, was now worthless. “That's a bigger call than any call I made,” she said, “and it didn't really get much note. But the [key] quote was, ‘You're only as solvent as people believe you to be solvent.’”

One of the reasons Whitney's call went unheralded was that her note came out around the same time that the ratings agencies decided to downgrade Bear Stearns, too. Whitney's downgrade was made on behalf of equity investors, who had already taken a drubbing in the past year on Bear's stock. The ratings agencies' revisions, however, were made for the holders of the firm's debt and went to the heart of Bear Stearns's ability to survive. It was as if the Fed's decision to step in and help the firm had done nothing whatsoever to calm creditors. Standard & Poor's cut its long-term credit rating on Bear Stearns by
three
levels, to BBB, and suggested
further downgrades were possible. “Although we view the liquidity support to Bear as positive, we consider it a short-term solution to a longer term issue that does not entirely affect Bear's confidence crisis,” Whitney wrote. “We also remain concerned about Bear's ability to generate sustainable revenues in an ongoing volatile market environment.”

Moody's and Fitch also cut their ratings on Bear Stearns's debt. “What their rating is now is irrelevant,” Andrew Harding, chief fixed-income investment officer at Allegiant Asset Management, in Cleveland, told Bloomberg. “Whether it's BB, AAA or A, I just think it's a response to the emergency funding today.” Not surprisingly, after the ratings agencies cut their outlook for Bear Stearns, the firm's cost of credit insurance—those credit default swaps—increased considerably, to as high as 810 basis points, up from 675 basis points the day before. In an interview with Bloomberg, Standard & Poor analyst Diane Hinton, a ten-year veteran, said, “In a normal market environment, we would not see this kind of movement, but we are not in a normal environment. One rumor gets started and people get more nervous than they already are and it becomes a feeding frenzy.”