House of Cards (21 page)

Dimon obviously agreed with Bernanke, Geithner, and Paulson that allowing Bear Stearns to fail was too risky a proposition. “We don't know what would have happened,” he said. “But I always look at what are the possibilities. And I think that [a meltdown of the whole system] had a very good possibility of happening…. So my attitude was we can't take that chance. We should fix it in the good old American way. You should feel good that a lot of people were up all night trying to get this thing fixed. And then go backwards and say, ‘What went wrong and how should we fix that?’” He made an analogy to someone who had been drinking and then went swimming and began to drown. It would be the wrong thing to do, Dimon argued, to say, “‘Well, moral hazard, they are drowning, let them die, that will teach them.' Bad idea.”

At 3:45 on Sunday afternoon, with the stakes growing exponentially and time running out, the five members of the Federal Reserve Board met in Washington to consider two historic decisions. First was whether to make a massive, $30 billion secured loan to a new company—eventually named Maiden Lane LLC, after the narrow street in downtown Manhattan that runs parallel to Liberty Street, the home of the New York Federal Reserve Bank—that would then buy $30 billion worth of Bear Stearns's most toxic assets and help to facilitate JPMorgan's acquisition. Second, as many Wall Street executives had been lobbying, was whether to open the discount window to securities firms, as opposed to commercial banks, for the first time since the depths of the Great Depression. The Fed's actions were meant to promote “orderly market functioning.”

In approving the $30 billion loan, the Fed cited the “unusual and exigent circumstances” and observed, in slightly less than its usual cryptic way, that “the evidence available to the Board indicated that Bear Stearns would have difficulty meeting its repayment obligations the next business day” and that “significant support, such as an acquisition of Bear Stearns or an immediate guarantee of its payment obligations, was necessary to avoid serious disruptions to financial markets.” The Fed noted that although “many potential investors” had been given the opportunity to make a deal for Bear Stearns, Bear “determined” that JPMorgan “was the most suitable bidder.” To make the deal possible, JPMorgan “had requested assistance in financing a specific pool of assets that Bear Stearns had difficulty financing in the market and that [JPMorgan] believed added significant uncertainty to the level of risk it would assume at the same time it was acquiring the remainder of Bear Stearns.” The Fed also approved two 18-month exemptions from its own rules that would allow JPMorgan, or its affiliates, to extend fully secured credit or guarantees to Bear Stearns and that would also allow JPMorgan to exclude the “assets and exposures” of Bear Stearns from the calculation of its tier 1 leverage capital ratio, effectively allowing JPMorgan to avoid raising new capital if the Bear Stearns assets ended up being worth less than originally thought. “It is fair to characterize both exemptions as unusual and significant,” explained Andrew Williams, a spokesman for the New York Fed. “There was some precedent for the 23A exemption”—transactions with affiliates— “but there was really no precedent for the regulatory capital exemption. We felt that the exemptions were an appropriate risk to take in light of the whole package deal. The 23A exemption was defensible because of its short-term nature, limited amount (50 percent of bank's capital), the full collateralization, daily mark-to-market, and indemnity from JPMC.
We also felt the short-term nature of the capital exemption was quite important—along with the fact that we did not provide exemption from capital rules at the bank level.”

With the Fed's $30 billion in hand, the only remaining open question appeared to be how much JPMorgan would offer to pay for the equity of Bear Stearns—and who would make that decision. The Fed's willingness to participate in the rescue in such a major way, to the tune of $30 billion of the American people's money, put the government in the unusual position of caring about an entirely different issue, that of the potential for creating a “moral hazard” if by rescuing Bear Stearns's debt holders and creditors, the government also provided financial comfort to the firm's shareholders. What kind of message would the market hear if the government rescued both the creditors and the shareholders of a bankrupt firm? Clearly, the Bear shareholders were going to have to suffer if the Fed was to be involved. Parr, in Lazard's requisite fairness opinion, noted that since the choice for Bear's shareholders was grim indeed absent a deal with JPMorgan, any price greater than a penny could be justified. So the overriding question quickly became, how low is low?

With this turn of events, the idea of the $10-per-share offer that JPMorgan had made on Saturday seemed preposterous. At 5:36, Noel Kimmel, who worked in Bear's prime brokerage business, wrote Paul Friedman looking for an update. Kimmel reported that the prime brokerage executives seemed “to be negotiating a contingency plan” with Goldman Sachs and Morgan Stanley “to be able to move client positions, then [Bruce] Lisman came out and thought a deal might be close. They want people around to call clients.”

Fifty minutes later, Friedman responded, “Latest rumor is that there will be an announcement of a sale to JPM at 7:00. Price is even lower than expected, as if that matters now.”

At 6:37, Kimmel responded, “Hearing $2 for the whole enchilada … what a steal.”

Replied Friedman: “You got it.”

In fact, Friedman missed the penultimate step, which was easy to do given how briefly it was available. “Chase came back and said $4,” Tese recalled. Having agreed to take $30 billion of Bear Stearns's riskiest assets onto the Fed's balance sheet, Paulson and Geithner phoned Dimon, who put the two senior regulators on speakerphone and told them he was thinking of offering $4 to $5 per share for the Bear. “That sounds high to me,” Paulson reportedly said to Dimon. “I think this should be done at a very low price.” At the same time as Dimon and the Feds were chatting, the Bear board of directors was ruminating about how $10 a share had
become $4 a share. Nobody in that room was very happy. Then Parr got an urgent message on his BlackBerry asking him to call Doug Braunstein, the JPMorgan M&A banker on the deal. “The time frame was relatively quick,” Parr remembered. “We barely had time to say the number was $4. There was enough time to begin discussing what that meant and for people to express their anger or disappointment.” He stepped out and called Braunstein. “He was apologetic,” Parr said. “He said, ‘I'm sorry to have to do this, but I do have to convey the number is $2.' To which I said, ‘You can't really mean that. Are you serious? You really don't want me to go back into the board and tell them this.' It was my way of partly trying to say to him, ‘Don't do this. Whoever you need to talk to there, [tell them] this is a bad idea…. The tone is bad enough. [The difference between $4 and $2 is] no money of consequence. It's not an amount of money … that's material in the scheme of things, so who do you need to talk to? You shouldn't do this.’”

But Braunstein had his orders. Explained Dimon later: “I tell people, buying a house and buying a house on fire are two different things. So it wasn't really the value. The people at Bear Stearns built a great company. A lot of them had nothing to do with doing this. It was how much risk can we bear? A lot of people are in the situation where you may have a great bargain but you don't have the money, or a great bargain but you can't get it home. That was all we could bear. So we needed what I call that margin of error [and] a lot of it has been used up [already]. Remember that day, when we signed that piece of paper, we bought someone else's $350 billion of assets. Honestly, that was all we could do. There was nothing else we could do. We wouldn't have done it. The issue wasn't the price at two or ten dollars. In any event, that was a very low price. The issue is, was there enough margin for error such that I can go to my shareholders a week later and a year later” and essentially defend his actions? “We just needed the margin for error. And without that, we simply couldn't do it.”

Parr hung up the phone and dutifully reported the news to the board. Bear directors were stunned by the new, lowball offer. “We didn't even get a chance to say, ‘How did you get $4?' when they came back and said $2,” Tese said.

“We just couldn't believe it,” Molinaro said. “There was already some sense at the board at $10 that it was an unfair deal, and we should just push the button and let's take our chances in bankruptcy.”

For his part, Cayne was livid. At breakfast with Tese earlier that day, he had come to realize that blowing up the firm wouldn't do anyone any good. But now, upon hearing that the JPMorgan deal was at $2 per
share—meaning that his six million or so shares, which at their height had been worth more than $1 billion, would now be worth around $12 million—he was incensed. His finger moved back over the red button. He wondered if the firm's bondholders, who together held $70 billion of debt and who in a merger with JPMorgan would be made whole but in bankruptcy would be severely impaired, should be asked to make a contribution to the shrinking pie for shareholders. The question was unorthodox for sure but in keeping with Cayne's proven ability to think through all the angles of a situation and land upon one that might improve his position. As Cayne knew, the bondholders had by far the most to gain from a deal with JPMorgan. Whereas all through the week, the cost of insuring against a default in Bear Stearns debt had been increasing rapidly—the so-called credit default swaps—a deal with JPMorgan would transfer these obligations to JPMorgan's balance sheet and immediately make them worth 100 cents on the dollar. In bankruptcy, these obligations would be worth pennies. “I brought up the fact maybe they should throw something into the pot because these guys are going to be made whole,” he said. “They got $70 billion of debt that's going in the tubes.” There was a clear recognition at the board level that there was a bailout under way for the holders of Bear's debt. “It was really important to Paulson, whether the number was $4 or $2 or whatever,” that it not appear to be a bailout, one person involved said. “He went on television: ‘This is not a bailout.' But it was a bailout to the creditors, the $70 billion.” The lawyers told Cayne that getting a contribution from creditors was unlikely to happen, especially in such a short time frame.

Recalled Cayne: “I then say, ‘Okay, well, so, let me get this straight. We take $2 as opposed to bankruptcy.' Right? Right. I said, ‘Okay, stop the meeting.' I want to talk to Dennis Block and Tony Novelly.” Block was the lead Cadwalader attorney advising the company and a longtime Bear Stearns legal advisor; Novelly, the CEO of Apex Oil Company and a Bear Stearns board member, had had direct experience with bankruptcy when the St. Louis—based Apex filed for Chapter 11 protection. According to the
Washington Post,
in the middle of negotiating with his creditors prior to the bankruptcy filing, Novelly “jumped up, according to various accounts, and made an obscene hand gesture at his bankers, called them stupid and walked out.” Novelly was also an outspoken advocate on the Bear board for pursuing the bankruptcy option.

Cayne left the meeting with Block and Novelly. “What does bankruptcy mean for a securities firm?” he wanted to know. “What happens in bankruptcy? How bad is it if Bear Stearns goes into bankruptcy? In the back of my mind I know I've got a board that ain't gonna vote for bankruptcy
regardless of how I feel. But on the other hand, I want to know. What are the actions? You just can't tell me $2 a share [or] goodbye, unless I've explored it and I agree that it's $2 a share or goodbye. Actually, as it turned out, 20¢ a share was okay, as long as we didn't go into bankruptcy, because in bankruptcy the fourteen thousand employees suffer dramatically. Dramatically. What's my responsibility? My responsibility was to the employees. My responsibility was shareholders, but I was a shareholder. My responsibility was to the bondholders, but they're big boys. They're buying at 300 over or 200 over, and they'll sell it at 100 over. I mean, there's no family there. But the fourteen thousand people, that's family.”

“The board meeting was very tense,” a board member recalled. “I think on Saturday night Jimmy was in the camp of ‘Fuck them, why don't we just take this thing under.'… I love Jimmy, but this card-player-that's-going-to-take-the-system-to-its-knees routine … isn't going to work. We had no idea what the alternatives are. We think we got this great hand to play … ‘You want to do that to us, then fuck you, we'll take the whole system down.' We have no idea what kind of emergency legislation they have in their back pocket to say, ‘They just took us down, here's the emergency relief to step in to keep the system from melting down.' They could have done all the same things that happened where we were actually being bought, only saying, ‘But you're not being bought. You're going into bankruptcy. You got no bankruptcy protection. You got no board. Your employees are out the door tomorrow. You got no indemnity. By the way, the U.S. attorney is going to be in and investigate you guys until the cows come.' But the most important thing is you have fourteen thousand people on the streets the next day. If you understand bankruptcy law, if you go into Chapter 7, there's a sign on the door, you don't show up. The phone's gone, the computer's gone, there's no severance, there's no nothing. We'd have had fourteen thousand people out on the streets because we don't need their lousy $2? So it was never something a thoughtful person could do, and I'm not saying that to diminish Jimmy. I mean, I know the emotion of the times. You think you've got a powerful hand here, but we're like a fucking kid in the schoolyard surrounded by bullies. In prison let's not show how tough we are. We're way over our heads here. That's why even on Saturday night, when we were doing the $10 deal, I told Sam, ‘Look, $10 should be $20 should be $30 should be $40, whatever. You've got to understand what we're facing in the alternative. This isn't the worst thing in the world.' By the time the $2 deal came around, all of a sudden the $10 deal looked good.”

Way back on Thursday night, the board's independent directors had
realized quickly that their interests might well diverge from the interests of Cayne and Greenberg, the two officer-directors (although technically, since he had retired as CEO three months earlier, Cayne was no longer an officer of the firm), and so they decided to hire their own legal counsel. Their choice was Rodgin Cohen, the head of Sullivan & Cromwell, who had made the call to Geithner on Wednesday night at home, on behalf of Schwartz and Molinaro, to tell him Bear Stearns was in trouble. Now he was back in a new role representing the independent directors. For a brief moment, while Cayne was contemplating voting against the $2 deal—which, he claimed, Paulson had actually wanted to be a $1-per-share deal—the independent directors, led by Tese, began to meet separately with Cohen to discuss their fiduciary responsibilities in this complicated situation. As for bankruptcy, Tese said, “I knew it wasn't a viable alternative. Rog knew it wasn't a viable alternative. Jimmy wasn't so sure. A lot of the bankers and the other people, they weren't so sure. But we were sure. Jimmy's a very smart guy. You explain things to Jimmy, he gets it. But he also said, ‘Well, why don't we tell them to go screw themselves?' And ‘$2 is like zero dollars.' And I said, ‘The independents outweigh everybody else.' So the independents met independently. There was a brief time there where the independents would have voted for a deal… because it was explained to us that anything is better than nothing. And there's $70 billion worth of bondholders that you have to consider. Therefore, if Jimmy doesn't want to vote for it, that's too bad.”