House of Cards (16 page)

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VEN BEFORE THE
downgrades that afternoon, Friedman knew he had completely misjudged the situation. The repo desk was right. The Fed's supposed lifeline proved to be nothing more than a poorly tied tourniquet on a severely hemorrhaging wound. Nobody wanted to do business with the firm. Bear Stearns had become like the proverbial frog placed in warm water that gradually becomes acclimated as the temperature is raised until it becomes cooked. “By the end of the day—we'd been downgraded by then, but even before that—every single lender had pulled their money, with three exceptions,” Friedman said. “It was all gone. The overnight lenders were all gone. Even some of the ones that were not overnight. Fidelity, for instance. We got in a huge fight with them. They had a $1 billion term trade on that they wanted to terminate. They kept arguing that this is not what they signed up for. It was after we had been downgraded, but they still argued, ‘You represented to us that you would remain an investment-grade firm. We're not willing to keep this outstanding. We want our money back.' They had actually done a trade first thing Friday morning to lend us money overnight, and they wanted that back, too. They wanted all their money back.” Added another Bear Stearns executive about the dangers of relying on repo financing: “When Bear's liquidity crisis developed, their repo book had expanded dramatically over the past year to the tune of two times the previous year. During the same period Lehman's repo book had declined by roughly 25 percent. Bear got
a taste of [its] own medicine by virtue of committing the cardinal sin of overreliance on short-term funding. For repo lenders, perception in many instances is reality. The last man standing gains nothing; the first out gets his money back.”

By early afternoon, Bear Stearns could see that the Fed's rescue plan was not going to work. “By midday, the money is gone,” Friedman explained. “The customers are gone. The customer credits are to the point where the wire room shut down. They couldn't process them fast enough. We had a lot of customers who had put money in money funds through us, and we were taking the money back from the money funds to wire out to the customers and couldn't do it fast enough. We actually ended Friday night with $8 or $9 billion of cash simply because we had to shut the room down because we couldn't get the money out.”

Shortly after Schwartz's conference call ended, Dave Schoenthal, the head of the firm's foreign exchange desk, told Friedman that counterparties no longer would do business with the firm and that Friedman had to do something. “I'm just physically and emotionally a mess,” Freidman recalled, “and I start to tell him, ‘Dave, I can't help you. There's nothing we can do.' I actually find myself sitting at my desk sobbing, with my head down on the desk. Literally. The tears are coming out. The combination of the whole thing, plus not having slept in two days, I've lost it, and David goes, ‘Oh,' and he was graceful enough to wander out of my office.”

What Friedman had discovered through the course of the day on Friday was that even though the Fed's back-to-back facility with JPMorgan appeared to be genuine, nobody knew how it was supposed to work—and of course there was no documentation for it. There was only the press release, which was hardly a blueprint for how to design and build a multibillion-dollar lending facility. “The JPMorgan facility is real, but they spend the entire day torturing us on it,” Freidman said. “They were insisting on 20 points margin on everything. Everything we do, they'll lend us 80 cents on the dollar on market value. So you give them something worth 100, even though they're not taking any risk, even though this is not how the facility was supposed to work. My repo guys are fighting with JPMorgan and grabbing our treasury guys to fight with JPMorgan. We're trying to get money. We're actually not getting any money. We have customer money going out, we have lender money going out, and JP is going, ‘We'll get to you.' In fairness to them, they didn't really understand it—maybe. Certainly their operational and treasury people were making it up as they went along. They're giving us an argument that they will only take collateral eligible at the discount window, which is a pretty limited list of things in terms of what you could get. By
midafternoon, we had only squeezed a couple of billion dollars out of them, and it's chaos.”

Chaos seemed to be the theme of the day. “We never really had time to figure out the line of credit,” Molinaro said. “It happened so quick. And the market reacted so badly. We had a very substantial run on the bank on Friday. Not only was the stock under pressure, but customers were trying to pull their money out at increasing levels. Prime brokerage clients, they didn't want to do business with us. Stock lenders didn't want to lend us securities. It was chaos. I think the tipping point of that day was the downgrade by the rating agencies. I think that tipped us over the edge. That was the end. Because when they downgraded us, there are money funds that can't own the paper, that can't do repo with you. I mean, people were just bailing. We were going to have very little repo capacity left away from the Fed, the way that this was going.”

A problem developed on Friday afternoon when State Street Bank, in Boston, and other large custodial institutions that provided back-office-type services to Wall Street refused to lend Bear Stearns securities overnight to cover their short positions or those of their customers. This seemed odd to Schwartz, since the firm supposedly had the backing of the Fed through its new lending facility with JPMorgan. But, as he well knew, the market was not responding with any confidence to Bear Stearns. Schwartz called Geithner and explained to him that the State Streets of the world were not behaving in a constructive way. Geithner called the bank and reminded it that Bear Stearns had the backing of the Fed, but State Street still was not willing to lend the securities overnight. “So we went, ‘Oh, shit,’” a Bear Stearns executive said of Schwartz's reaction. “He knew we had a big problem then.” By the end of Friday, Bear Stearns estimated that its available liquidity had dropped to $4.8 billion, from $18.3 billion on Monday, and that its funding requirements on March 17 would be between “$60 billion and $100 billion assuming counterparties to secured repo facilities were unwilling to renew these facilities.”

In retrospect, Molinaro wondered if the firm should have anticipated the downgrades by the rating agencies. “I think the downgrade really killed us. Really made it almost impossible to operate. The downgrade triggered so many bad things…. There were money funds and other institutions that are lending you money through the repo lines that can't do business with you if you're not rated at least single-A. If we had not been downgraded, my guess is we wouldn't have had as big a run on the bank. We would have needed to borrow less money from the Fed, and we probably would have got through that day in reasonable order.”

Begleiter also suspected the JPMorgan facility wouldn't do Bear
Stearns any favors. “We were able with this—whatever you want to call it— arrangement that came out in the wee hours of Friday morning, to work our way through Friday, but I didn't know how we were going to get through Monday if something didn't happen over the weekend,” he recalled. “Without the Fed facility, we were probably going to file bankruptcy shortly afterwards unless we sold the company or got a major investment over the weekend. The liquidity we started the week with had eroded. Now, some of it was due to be replenished because of the timing of flows, but if you fail, you fail. You don't get a chance to say, ‘Hey, we'll pay you in two days, as soon as we get the money we are owed from others.' Everything conspired to work against us. For example, other firms were demanding margin from us but not sending us margin they owed us. We had customer money that needed to go out, which we had in segregated deposits, but there's a process to get it released and that takes a couple of days even though the customer wants his money right away. There were many other items that contributed to the cash drain. It all happened very quickly.”

Tom Flexner, the Bear Stearns vice chairman, had been out visiting clients on Friday for most of the day. But when he returned to the office Friday afternoon, he knew that the JPMorgan facility was not working the way everyone at the firm had hoped it would. “From what I was told by our treasury department… we were posting collateral to JP and it was haircutting at 20 percent, and then taking the same stuff to the Fed and getting 98 cents on the dollar for it,” he said. “This was a liquidity facility that was putting us out of business, and JP was making money off of it. Sam Molinaro told me at one point that we had to post $25 billion of collateral to get $15 billion in liquidity. That's game, set, match.”

With his firm looking on Friday afternoon increasingly like St. Sebastian—and feeling especially rattled that Geithner's call to State Street had not worked—Schwartz decided he had better speak with his contacts at the Federal Reserve and the Treasury to give them an update. He placed a call to his friends Robert Steel, a fellow Duke alumnus and undersecretary of the Treasury, and Kevin Warsh, a thirty-eight-year-old former Morgan Stanley M&A banker turned Fed governor. Even though Schwartz believed he had up to twenty-eight days to fashion a solution, he worried that the events of Friday afternoon had made the government extremely nervous about the potential repercussions for the whole financial system. “I understand completely that you guys are in a situation that all you can worry about is what's going to happen in the market and the U.S. economy,” Schwartz told them. “I'm not calling you as a favor for Bear Stearns; I get it. It just so happens, in my opinion, if we can keep this alive and I can get this thing sold at 40 bucks a share or 50 bucks a
share, it's a heavy discount from book so there's got to be people that want to do it. That's a much better outcome for the market than waking up and finding out that over a two-day period Bear Stearns was toast. So we really need to work together to figure out what's not working here and get it done.” Both Steel and Warsh told Schwartz, “We hear you.”

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he exhausted Bear Stearns management team started heading home at the end of the day on Friday knowing that while things were looking grim, at least they could take comfort that they still had another twenty-seven days to try to find a more permanent solution to the funding crisis. While it was true that the JPMorgan facility was not working particularly smoothly, at least it would allow the firm to continue operating. Schwartz felt that Steel and Warsh understood the predicament. “We left Friday night thinking that we'd be at it through the weekend, negotiating with JP Morgan over the sale of the company,” Molinaro said. “That was kind of our plan. We thought we'd be talking to them through the weekend over a possible sale and begin the process.” Indeed, that afternoon that process had already begun, with Jeffrey Woods, the chief operating officer of JPMorgan's investment banking business in North America, contacting Steve Begleiter and suggesting that “tomorrow would be much more productive” if JPMorgan's bankers “can get access to available content tonight.” The Bear team agreed Friday afternoon to get JPMorgan “up and running as soon as we receive a signed” confidentiality agreement regarding the nonpublic information to be shared.