House of Cards (20 page)

Jamie Dimon then called Geithner downtown and told him the news. Given the unknowable interconnectedness of the various firms and their counterparties worldwide, Geithner decided he could not—the world could not—afford to risk the liquidation of Bear Stearns. “For the first time in history, the entire world was looking at the failure of a major financial institution that could lead to a run on the entire world financial system,” a Fed official recalled. “It was clear we couldn't let that happen.” Geithner called Dimon back and urged him to keep working on the deal. That call initiated several hours of back-and-forth discussion between JPMorgan and the Fed about how a deal might be cobbled together— with the Fed's considerable help—before the markets opened in Asia at 7
P.M.
New York time on Sunday evening.

Word started trickling out at 383 Madison that JPMorgan had passed on the deal, although the parties had agreed to continue negotiating and marking up the contracts, assuming a deal could be somehow orchestrated with the Fed. “We went to bed on Saturday thinking we might have had a deal with JPMorgan, at $8 to $12,” Bear board member Fred Salerno recalled. “Get up Sunday, JPMorgan's out. Whether they were trying to position for a better deal or really had concern for itself, I had no idea, but clearly it is what it is. If I were Jamie Dimon, I would have had some concerns myself because you never do a deal as big as that on one day's due diligence. What's the upside versus the downside? So I give him that benefit of the doubt. I would have had a hard time with it, although at eight to twelve bucks it sounded like a great deal economically, but I would have had a hard time. Give him credit that this is really an issue that he was uncomfortable with. But it was very disappointing to us because we thought we had a deal.”

Everyone at Bear Stearns just sat around and waited. For his part, Molinaro too did not think JPMorgan was pulling a fast one on Sunday morning. “I think that they were nervous about—everybody was nervous
about—us going into bankruptcy,” he said. “That was going to be a bad outcome because they were a huge financial markets player. They have enormous credit derivatives exposures, mortgages, they've got all the same stuff we do. They have counterparty exposures to worry about. Systemic failure problems could exist. I think they were very nervous that if you take a major player and it just implodes in the market, it's uncharted waters. Nobody knows what's going to happen. Whatever it is, it's not going to be good. I heard that they had assessed their exposure in the billions to our going out of business.” In fairness, Molinaro believed JPMorgan had a tremendous amount to analyze in a short amount of time. “They had to get their arms around the mortgage book,” he said. “They had to try to figure out if there were any other landmines that might be out there that weren't apparent. Litigation had to be understood. And our liquidity picture needed to be understood.”

Naturally, the delay was discouraging to the rank and file. “We decided to send everyone home,” Friedman said, “and then we went back to huddling with the bankruptcy lawyers. We were back to figuring out how we declare bankruptcy.” Richie Metrick, a longtime consigliere to Alan Schwartz, urged caution. “Don't worry, we'll have a deal by seven o'clock,” he told people, referring to when Bear Stearns had to open for business in Asia on Monday morning.

When Tese and Cayne returned to 383 Madison, they learned that the JPMorgan deal was off. “Everybody felt there was brinksmanship going on,” Tese said. “Chase [didn't] have to do this.” On the other hand, “that portfolio was what it was. [Chase] didn't have a chance to scrub it the normal way you would scrub it. They really didn't know what the bottom was in this market. So even if the portfolio was everything [Bear] thought it would be, there was still a lot of exposure on that portfolio, because of the way the market is.”

Throughout the day on Sunday, the Flowers team continued to work on crafting a proposal, but it was increasingly looking futile. Parr and Flowers explored the idea of selling pieces of Bear's businesses. Flowers told Parr he was hoping to find buyers for Bear Stearns's prime brokerage and derivatives businesses and then—assuming the elusive financing could be found—make an offer to buy the rest of the company. But, given the short time frame, none of the deals Flowers was contemplating came together. “It's not unlike any M&A process,” Parr said. “We try to run things in parallel and keep optionality. When I go to core beliefs about investment banking, one is to always have options. Don't ever get narrowed down to one thing until you're done. Always have options. So in trying to run parallel, I continued to make phone calls to people. There
were still some that were ‘maybes' or ‘might have an interest in a business.' There was a point of time where I had conversations with Lehman about doing something in the mortgage area. Then there was a time when I had conversations with John Mack, at Morgan Stanley. We had conversations with Goldman about the prime brokerage business.” One idea was for Goldman to invest in the parent company of Bear Stearns and have that investment convertible into an ownership position in the prime brokerage business. But all of these ideas—while interesting and creative— required the luxury of time, which simply was not available.

The only real hope remained JPMorgan. But the firm had stopped its due diligence process at 383 Madison. The Bear faithful were despairing of finding a savior. Cohen went out to lunch with one of his colleagues and lamented, “I've worked on so many of these rescues and it's the first time I've felt quite this helpless.” He said the five hours on Sunday after hearing JPMorgan would not proceed with the deal were torturous. People were “just shell-shocked,” Cohen remembered.

Marc Feuer e-mailed Paul Friedman around one o'clock with another false report. “I heard that we're done, news release @ 3.”

“Not even close,” Freidman replied. “JP is bailing out.”

“Truth?” Feuer shot back.

“Yup,” said Friedman. “Financial chaos.”

“Financial chaos if the proposed deal goes thru?” Feuer wondered.

“No, if it doesn't,” Friedman corrected his colleague. “And right now I don't think it will. We go toes up.”

Friedman saw Richie Metrick around four in the afternoon. “Richie, any word?” Friedman asked.

“Is it 7
P.M.
yet?” Metrick responded. “No? So, why would you expect anything?”

At 4:40 on Sunday afternoon an exasperated Friedman wrote Feuer about the silence: “The (optimistic) view is that this was JP's plan all along: bid, pull the bid, string it out to the last minute to force the Fed to take all the risk and then steal us cheap AND risk free. The pessimistic view is that we're wrong, JP truly has no interest and the world's financial system ceases to exist tomorrow.”

Although not apparent to those wandering the halls of Bear Stearns, JPMorgan was busy explaining to Geithner and Paulson that in order to consider seriously a deal for Bear Stearns, the bank needed an unprecedented amount of financial support from the Fed. Dimon, who had concluded that the toughest problem was the extra $30 billion of Bear Stearns's mortgage-backed securities and leveraged loans, asked the Fed directly for that support. “The New York Fed indicated that it would be
willing to consider the possibility of an arrangement that would result in the New York Fed assuming some of the risk associated with the Bear Stearns balance sheet,” the firm blandly reported later. “As a result of these discussions, it was agreed that as a part of a transaction, the New York Fed would provide $30 billion of non-recourse funding secured by a pool of collateral consisting of mortgage-related securities and other mortgage-related assets and related hedges.”

The import of this massive direct intervention to save a securities firm from failing was historic. Yet there was little choice, the key participants felt at the time. “People were saying, ‘You have to save them, you're JPMorgan!’” Dimon remembered. “It was a wise thing to do…. JPMorgan should not stand in the way of doing something good because we're being selfish or parochial.” He later clarified his thinking. “My perspective, from the start,” Dimon explained, “was that we could not do anything that would jeopardize the health of JPMorgan. That would not be good for our shareholders and it would not be good for the financial system. But I also felt that, to the extent it was consistent with the best interests of shareholders, we'd do everything we reasonably could to try to prevent the systematic damage that the Bear Stearns failure would cause. We and the whole board—we, the management team, and the whole board of the company—viewed that as an obligation of JPMorgan as a responsible corporate citizen. By Sunday morning, we had concluded the risks were too great for us to buy the company entirely on our own. We informed the New York Fed, the Treasury, and Bear Stearns of our conclusion. This wasn't a negotiating posture. It was the plain truth. The New York Fed encouraged us to consider what kind of assistance would allow us to do a transaction. That is what we did.”

By this time Geithner and Bernanke had also concluded there was no other way to save Bear Stearns—and potentially other firms, such as Lehman Brothers or Merrill Lynch, which were similarly at risk—if the Fed did not act, and with authority. Even the leading Senate Democrats on the Senate Banking Committee, Charles Schumer, of New York, and Christopher Dodd, of Connecticut, said they supported the decisions made over the weekend by Paulson, Bernanke, and Geithner. “When you're staring into the abyss, you don't quibble about details,” Schumer said. Added Dodd: “I believe this is the right action that was taken over the weekend. To allow this to go into bankruptcy, I think, would have [created] some systemic problems that would have been massive.”

But on Sunday morning, when Paulson appeared on ABC's
This Week,
he gave no indication how high the stakes had been increased since the Fed stepped in on Friday morning. He dutifully defended that
decision when asked about it by George Stephanopoulos. “The right decision here, I am convinced, was the decision the Fed made, which was to do things, work with market participants, to minimize the disruptions.” He said he was “very aware of moral hazard. But our primary concern right now—my primary concern—is the stability of our financial system.” When Stephanopoulos asked Paulson if the Fed's back-to-back loan to Bear Stearns had solved the problem, Paulson used evasive tactics, even though he knew full well that the situation was then at its most flammable. “I'm not going to speculate about what the outcome of this situation is going to be,” he said. “We're working our way through this right now. We have a lot of conversations going on.” When Stephanopoulos asked Paulson about a comment by William Fleckenstein, president of Fleckenstein Capital, that Gretchen Morgenson had featured in her column that morning—“Why not set an example of Bear Stearns, the guys who have this record of dog-eat-dog, we're brass knuckles, we're tough? This is the perfect time to set an example, but they are not interested in setting an example. We are Bailout Nation”—Paulson demurred and said that “every situation is different” and “we have to respond to the circumstances we're facing.”

There were certainly voices—including Fleckenstein's and even some within Bear Stearns itself—that the free market should be the one to render judgment on the firm's years of strategic and tactical choices, among them the decisions to finance itself with short-term borrowings, to pack its balance sheet with hard-to-sell and hard-to-value mortgage-backed securities, and not to diversify its revenue either geographically or by product. “My personal view is that [Bear Stearns] should have been made more of a victim,” said one Bear senior managing director. “I don't think it should have been saved. I don't buy the argument that the whole system would have unraveled and collapsed. I really don't. I think it's a terrible precedent. I don't think the Fed should be in the business of assuming this kind of risk. I think it would have been a much better wake-up call for everybody had things followed their course.”

However, this was not a risk that Paulson, Bernanke, or Geithner was willing to take. “On March 13, we learned from the SEC that Bear Stearns was facing imminent bankruptcy, and this presented us with some extraordinarily difficult policy judgments,” Geithner explained. “Bear Stearns occupies—occupied—a central position in the very complex and intricate relationships that characterize our financial system. And, as important, it reached the brink of insolvency at an exceptionally fragile time in global financial markets. In our judgments, an abrupt and disorderly unwinding of Bear Stearns would have posed systemic risks to
the financial system and magnified the downside risk to economic growth in the United States. A failure to act would have added to the risk that Americans would face lower incomes, lower home values, higher buying costs for housing, education, other living expenses, lower retirement savings and rising unemployment. We acted to avert that risk in the classic tradition of lenders of last resort with the authority provided by the Congress. We chose the best option available in the unique circumstances that prevailed at that time.”

Bernanke said he, too, became concerned by Bear Stearns's deteriorating liquidity position during the week and then especially by the market's counterintuitive reaction to the back-to-back financing facility that the Fed had made available on Friday morning. “This news raised difficult questions of public policy,” he said. “Normally, the market sorts out which companies survive and which fail, and that is as it should be. However, the issues raised here extended well beyond the fate of one company. Our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a range of critical markets. The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence. The company's failure could also have cast doubt on the financial positions of some of Bear Stearns's thousands of counterparties and perhaps of companies with similar businesses. Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain. Moreover, and very importantly, the adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability.”