House of Cards (18 page)

Flowers went through Bear's books thoroughly and came away impressed. “Your books are in a lot better shape than I thought they would be,” he told Schwartz and others, and recounted some “horror stories” about what he had found at other firms where he had been asked to consider an investment. He added: “I've never been through a process where we could get answers from people who knew what they were talking about.” On the other hand, he said, he felt as if he were in the “middle of a hurricane” and wished the process could have been less pressured. Still, he pledged to work hard and to try to cobble together a group of banks to provide billions in financing. He also hoped that he could somehow convince the Fed to open the discount window to Bear Stearns as part of any deal he might do. Schwartz knew well the long odds Flowers faced. But he also needed Flowers to be a serious competitor to keep JPMorgan honest.

There also had been some belief that Deutsche Bank and Barclays—the giant German and British banks, respectively—or maybe even Goldman Sachs, the Blackstone Group, or Warburg Pincus might be interested in making a run at Bear Stearns, but when it came to crunch time, none of those other institutions decided it made sense. Deutsche's partner on its potential bid was to be the publicly traded Fortress Investment Group, a global hedge fund and private equity firm. From August 2007 until around the time that Schwartz took over as CEO from Cayne, in January 2008, Fortress had been taking a serious look at merging with Bear Stearns. Even though Fortress was the smaller firm by some two-thirds at that time, Fortress's well-regarded CEO, Wesley Edens, was to have been the CEO of the combined firm, which may have been enough of an obstacle for Schwartz to kill the deal two months earlier. With Deutsche deciding against a bid for Bear Stearns, Tom Flexner, the Bear vice chairman, invited Edens, his client and longtime friend, to join him at 383 Madison to witness the historic events then unfolding, and to help Schwartz and Molinaro if asked. Flexner had planned to be out of town that weekend, but after Friday's extraordinary events, he changed his plans. “There was no way I was going to miss the front-row seat,” Flexner said. “Just so I could tell my grandkids someday.”

The due diligence centered around two key but difficult-to-discern facts—the assets that Bear Stearns actually owned and their value, and the firm's “funding vulnerabilities”—in other words, how much money
the firm needed to continue operating come Monday morning. That shortfall was, more than likely, the amount of federal funds that would have to be made available if a deal was to happen. In rough numbers, if Bear Stearns's balance sheet had $400 billion of assets and $100 billion in long-term capital, that left some $300 billion that needed to be financed to support those assets. Of that $300 billion, about $150 billion consisted of Treasury securities and another $100 billion consisted of “agency” securities, Freddie Mac and Fannie Mae—all of which could be used as collateral for repos or for a margin loan, assuming markets had normalized somewhat. By this logic, Bear Stearns's funding gap that weekend was around $50 billion, but this was just a rough guess. On Saturday, Flexner recalled, they were trying to determine the size of the problem. “Because if the problem is $3 billion, you can get it solved. Fortress will write the check. If it's $30 billion or $40 billion, it takes a major bank, probably with Fed backing. Remember, this was all happening in an unprecedented and condensed time frame to do a merger, to get one of the largest deals in the history of the financial services industry done in two days. It was wild.”

While the due diligence was being done at 383 Madison on Saturday morning, the full Bear Stearns board of directors met by telephone for the first time since Paulson had rendered his sobering decision. Some of the board members had heard the news the night before, but not all of them. “That was a very down meeting,” Rog Cohen remembered, “because that's when everybody on the board was informed that the twenty-eight days was two and a half at that point.” After that board meeting, Cohen “rushed” into Bear Stearns, arriving around 1
P.M.
, and then spent the next twelve hours negotiating with JPMorgan, the Flowers Group, and the federal government about what, if anything, could be done.

W
HILE ALL THE
parties were getting their minds around the magnitude of the funding need, Flowers made a preliminary proposal whereby his funds would invest $3 billion into the firm in exchange for a 90 percent fully diluted stake in Bear Stearns. The Flowers deal valued Bear's equity at around $2.80 per share, well below where it had ended the day on Friday afternoon. But his deal had two major contingencies. First, Flowers would need to assemble a consortium of banks willing to provide Bear Stearns with the $20 billion of financing he thought Bear needed to continue operating. And in case that was not enough money to keep the firm fully financed, Flowers also required a commitment from the Federal Reserve that Bear would have guaranteed access to its discount window to obtain additional loans, if needed, for one year. Given that no investment
banks had access to the Fed's discount window at that moment, Flowers's second condition made sense theoretically but was inordinately impractical, especially under the tense circumstances. “I think what the Fed basically told Flowers,” Cohen said, “was, ‘Look, we're not saying no, but we're certainly not saying yes unless you've got the funding.’” But the Fed encouraged Flowers to keep working on a proposal, as far-fetched as it was. “Not for our benefit,” Molinaro said, “just for theirs.”

“We were past Plan B and up to Plan C or D and possibly beyond,” Friedman said. “This was the most absurdly impossible thing to ever imagine that they were going to do—that they were going to put in a couple of billion dollars and they were going to arrange some loans for us, and the whole thing was going to be predicated on the Fed allowing us to go to the discount window, and Flowers was going to arrange that, well, it was like,
‘Okay
.

Despite the problems with Flowers's proposal, Gary Parr, at Lazard, took it seriously enough—or seriously enough as a useful stalking horse— that he reviewed the details of the proposal with Bear's senior management, which then authorized Flowers to make the calls necessary to see if the $20 billion of financing could be raised. But this remained a long shot, “because without access to the Fed window, a $3 billion injection or a $6 billion injection, it doesn't matter,” said one senior Bear banker. “We've lost $20 billion in 24 hours, so what was $6 billion going to do for us? The game was over. Flowers continued to do its work and they were coming up with more money. They had five or six financial institutions, which all ended up bailing on them anyway. There was just nothing to do. It was a disaster. That was the end right there.” Added Cohen: “I think within that extraordinary pressure cooker, although Flowers is an extraordinarily smart guy and he has smart people around him, I think they did a lot of due diligence just around the $20 billion or so, but it was not in the cards.”

There was no question in anyone's mind, from the Fed and the Treasury on down, that if a deal was to be consummated by Sunday evening, JPMorgan would have to be the buyer, for all the very same reasons that the firm had been the best candidate to provide rescue financing twenty-four hours earlier. At around five in the afternoon on Saturday, Bloomberg reported that Royal Bank of Scotland was interested in buying Bear. But that was an error; it was the Royal Bank of
Canada,
not Scotland, that “likes us a lot,” Friedman reported, but there were too many issues and not enough time for that bank to get serious. “Everything else was noise over the weekend,” a senior Bear banker said. “Flowers being there became noise. Goldman being there was noise, Blackstone and Warburg at a minimum I know had made phone calls on Thursday and
Friday saying, ‘We'd like to come in and help.' But it was too late. They could never have done what they needed to do. Nobody had an A-plus balance sheet to back anything up. So all of that was noise. It was all bankruptcy or JPMorgan.”

M
ORE THAN TWO
hundred of JPMorgan's top managers were conducting due diligence with their Bear Stearns counterparts. In addition to the group working at the Bear Stearns offices, JPMorgan had set up a war room on the eighth floor of the big bank's 270 Park headquarters, in and around the office of CEO Jamie Dimon. On Saturday evening, with some considerable misgivings and a feeling that not enough work had been done, JPMorgan's bankers met with Parr, from Lazard, and Schwartz and Molinaro, from Bear Stearns. According to one of the participants in the meeting, “Jamie said, ‘Look, you're not going to like this, blah, blah, blah, but if we have to do it over the weekend it's going to be $8 to $12.' Then Schwartz said, ‘Yeah, I'm not going to like it, but all I got is the weekend.’” In that meeting, based on its preliminary due diligence, JPMorgan said it was willing to consider an all-stock deal for Bear Stearns that valued the company between $8 and $12 per share, which in Wall Street talk meant that JPMorgan was thinking about offering $10 per share. At that valuation, which was two-thirds below the Friday closing price but obviously higher than what Flowers was thinking about or the goose egg that shareholders would receive in liquidation, JPMorgan also wanted a few other goodies: an option to purchase 19.9 percent of Bear Stearns stock (as a way to help ensure that shareholders would vote for the deal) as well as options to purchase the two assets the bank most coveted—the seven-year-old Skidmore, Owings & Merrill—designed headquarters building at 383 Madison, which it could use to house its dispersed investment banking operations, and the prime brokerage business that cleared trades and managed accounts for hedge funds. The JPMorgan representatives made clear that their “thinking” was “still preliminary” because they were awaiting further reports from their due diligence teams and that the ultimate price “could be lower than $8 per share.” There was by no means a uniform view at JPMorgan that the deal made sense. One senior banker in the firm's asset management division who had been reviewing the similar business at Bear reported, “This is insane. Why would you ever want to take on this piece of shit, other than out of some sort of patriotic sense of obligation?”

At 9:15 Saturday evening, Friedman sent a “confidential” e-mail to Craig Overlander and Jeff Mayer, the two heads of fixed income, with the news that “Alan and Sam are with JPM. They showed us a bid of 8–12/
share. I'm with Flowers but I think they have no shot, if only because their plan assumes we can get to the [Fed] window directly.”

Dimon then called Schwartz. “Okay, things are looking pretty good, we'll talk tomorrow,” Dimon said. “But I don't want to go through all this if your board is going to turn it down. So I need to know you're prepared to do something in this range.”

Schwartz responded: “Well, I have to know that you're prepared to do it, too. I know you can't get board approval without a board meeting, but I have my board sitting here and you've talked to your directors. So where are you guys?”

Dimon replied, “Well, let's just say I'd be very surprised if they turned it down.”

Schwartz said, “Okay, talk to you in the morning.”

With time and choices dwindling rapidly, Bear's board of directors met on Saturday night to hear from Parr about the current state of the proposals from Flowers and JPMorgan. “I think the board was obviously very disappointed,” Cohen said about the JPMorgan offer, “but Alan made it clear the Flowers deal remained both more problematic and of no greater value. There was a discussion about could there be others and there was no time to do that. Again, the company had zero negotiating leverage. So we did advise the board that in addition to price we had to have absolute certainty of closing. We went back and the board accepted it. Again, it's a board where there were realists. Schwartz was a realist, Tese was a realist, Fred Salerno was a realist. And I think Ace was a realist. I'm talking about people who spoke up and said something.”

Molinaro agreed. “The board's reaction to it is that everybody was surprised by the number, because it was low,” he recalled. “There was some feeling of helplessness. [Still, it was] better than zero. Could have been zero. At least it was a number. We were really not in a very good negotiating position.” Jimmy Cayne, who had arrived in New York at around 6
P.M.
on Saturday on a private jet from Detroit, heard the news about the value of the proposed deal and started doing the math. “I'm saying to myself [I've got] six million shares, I just got my ass kicked,” he recalled. “But I was almost dispassionate, because to me, $8 and $12 were the same. It was not $170, and it wasn't $100. And it wasn't $40. The only people [who] are going to suffer are my heirs, not me. Because when you have a billion six and you lose a billion, you're not exactly like crippled, right?”