House of Cards (56 page)

T
HAT SAME MONTH
, shortly after announcing quarterly net income of $181 million—powered yet again by the firm's fixed-income businesses, “with [a] particularly strong performance from our industry-leading mortgage-backed securities department,” Cayne emphasized in an SEC filing—Cayne decided to start writing a bridge column in the now defunct
New York Sun
with Michael Ledeen, the controversial neoconservative scholar at the American Enterprise Institute who played a role in the Iran-Contra scandal in the second Reagan administration. He was a fine bridge player in his own right, although not on a par with Cayne, and had authored
Machiavelli on Modern Leadership,
a book about the relevance of Machiavelli's philosophy to modern business leaders. Cayne
loved the book, one of the few he has read. In their June 4, 2002,
New York Sun
bridge column, titled “Making the Best of a Bad Situation,” the men observed, “As in life, much of bridge has to do with blunders and accidents. One of the big differences between winning and losing bridge players—as in most competitive aspects of life—is that winners learn to make the best of difficult situations.” The same could easily have been said about Cayne in the years following September 11 and the firm's move into Cayne's tower at 383 Madison Avenue. Suddenly, as never before, the press and the market latched on to the idea that Cayne was playing a poor hand exceedingly well.

In October 2002,
Forbes
published “The Card Player” about Cayne and immediately created the impression that somehow Bear Stearns had managed to avoid the malfeasance other firms had committed with their investment bankers and research analysts. “Here's one investment bank not on Eliot Spitzer's hit list,” the article stated, ignoring completely that the firm had committed many of the same sins involving investment bankers and research analysts—albeit less grievously—as had Salomon Brothers and Merrill. “They say that a card player's skill is shown by how well he plays a bad hand,”
Forbes
observed. “The bear market has dealt every Wall Street firm a bad hand, and Bear Stearns' skills are showing through.” The article recounted how the firm's net income had increased 21 percent through the first nine months of 2002, compared to 2001. “Credit goes to … Cayne,” the magazine concluded. In early March 2003,
Fortune
stunned Wall Street by declaring Bear Stearns the “most admired securities firm” of 2002, ahead of both Goldman Sachs and Morgan Stanley. Bear had placed seventh on the list of most-admired securities firms the year before.

Then, on March 28, both the
New York Times
and the
Wall Street Journal
published articles lauding Bear Stearns's ability to thrive in a difficult market. The
Journal
headlined its article “A Contrary Bear Stearns Thrives,” while the
Times
ran “Distinct Culture at Bear Stearns Helps It Surmount a Grim Market.” Cayne declined to speak to the
Journal,
but Spector observed that the firm's decision to cut $300 million from its expense base starting in 2000 “sent a message that we're paying attention to the bottom line. People got it.” Added Sam Molinaro, “We've always been skeptical of the herd mentality. It means we may miss some business in the short run but we do better in the longer run.” The
Journal
article observed that part of Bear's success was due to luck—that it never had been big in M&A or equity underwriting (two businesses that had slowed considerably by 2003) or in catering to small investors. The firm
had also “failed to fully broaden its earnings away from bonds, stock-clearing and other specialities, which it sought to do in the mid-1990s.” Now that singular focus seemed to be paying off. “Bear Stearns' bond operation, overseen by Mr. Spector, picked up ground as the bond market surged,” the newspaper wrote. “Bear Stearns now is the biggest player in the raging mortgage-underwriting business and the fourth largest in municipal bonds. In comparison, the firm was third in mortgages and eighth in munis three years ago.” Bear underwrote $98 billion of mortgage bonds in 2002, up from $22 billion in 2000, and appeared headed to underwrite north of $100 billion in mortgage bonds in 2003. Spector predicted a bright future for the firm. “We'll underperform if we go back to the insanity of 1999 and 2000 but if equity picks up we'll do as well as anyone else because of our stock clearance and wealth-management businesses.”

In the dueling laudatory articles, it was Landon Thomas Jr., at the
Times,
who had Cayne “kicking back in his swivel chair” behind his “sweeping half-moon desk” to opine that what kept him up at night was the big bets his traders were making down the hall. “I'll tell you what worries me,” he told Thomas. “That we might be doing something stupid.” Cayne seemed at once cautious—“We are hitting on all 99 cylinders,” he said, “so you have to ask yourself, What can we do better? And I just can't decide what that might be”—and cocky. “Everyone says that when the market turns around, we will suffer,” he said. “But let me tell you, we are going to surprise some people this time around. Bear Stearns is a great place to be.” In keeping with past precedents, he also was unapologetic about his 2002 compensation—$18 million, including $10 million in cash—which made him the highest-paid executive on Wall Street. Schwartz and Spector made $17 million each. Cayne even defended the entire Wall Street compensation scheme, which had been transformed from one of shared liabilities back when the firms were private partnerships to one of encouraging bankers and traders to take short-term risks with other people's money in the hope of making a huge, no-strings-attached bonus. “This is not an ordinary business,” Cayne told Thomas. “My father was a patent attorney, and he never made more than 75 grand in his whole life. But if I don't pay my guy $1 million, nine of my competitors are willing to pay him four times that.” As to the inevitable question about who would succeed Cayne, then sixty-nine, and when, Thomas noted there was “a spring in his step that belies his age” and that Bear Stearns's executives had a “history of working into their 70s,” although the only one to have done so was Greenberg. Schwartz or Spector? Thomas wanted to know. “It's the $64,000 question,” Cayne replied. “But there are no cabals or coups here. These guys are not champing at the bit.”

L
URKING THEMATICALLY THROUGH
the spate of positive coverage of the firm was the question of why Cayne had not diversified the firm away from its huge concentration in fixed income and clearing. True, that decision had proved lucrative to Bear Stearns in the wake of September 11 and Fed Chairman Alan Greenspan's aggressive campaign, starting in January 2001, to lower interest rates (rates dropped thirteen times between May 2000 and June 2003, going from 6.5 percent to 1.00 percent, with eleven of those rate decreases coming in 2001 alone). “The Fed's easy-money policy put a lot of the wind at the back of some of the transactions in the housing market and elsewhere we are now suffering from,” explained Glenn Hubbard in December 2008, looking back at the time when he was chairman of the White House Council of Economic Advisers. The consequences of Greenspan's monetary policy would soon be felt—with dramatic consequences—across the global financial markets. “Investors said, ‘I don't want to be in equities anymore and I'm not getting any returns in my bond positions,'” explained William T. Winters, the co-head of investment banking at JPMorgan Chase and one of the developers of the derivative products so prevalent today. “Two things happened. They took [on] more and more leverage, and they reached for riskier asset classes. Give me yield, give me leverage, give me return.” Bear Stearns put itself at the epicenter of those consequences because of its reliance on fixed income—specifically mortgage-backed and other asset-backed securities—for its profitability and because of its failure to diversify when it had numerous chances.

The blame for the firm's failure to diversify, as Cayne now admits, rested squarely on his shoulders. In this sense, he became a Sophoclean tragic hero, ruined by his own terrible choices. For instance, in 2001, Spector brought to Cayne's attention the opportunity to buy asset manager Neuberger Berman, which at the time was publicly traded and had around $56 billion in assets under management. Bear Stearns Asset Management had about half that amount. The marriage could have been a beautiful one, as they say in Hollywood. But Cayne did not want to pursue the deal, even though Bear Stearns could have had the business for around $1 billion less than the $2.6 billion that Lehman Brothers paid in cash and stock in July 2003. “Acquisitions weren't my forte,” Cayne said. “They had forty-seven brokers. That's what it was. Lehman paid $3 billion for forty-seven brokers. Who would dream of doing that? I wouldn't pay anything for forty-seven brokers.”

Bear Stearns also had several opportunities to buy Pershing, the large clearing business that at the time was part of Donaldson, Lufkin &
Jenrette. The first opportunity to buy Pershing came around the time Dick Harriton left Bear Stearns. Harriton had been friendly with the head of Pershing and together they cooked up a plan to merge Pershing into Bear's clearing business and then have both Bear Stearns and DLJ go private. It was a bit of a long putt, but Harriton was convinced Bear could have had Pershing for $250 million. He took the idea to Alan Schwartz, who thought it was a great idea, but told Harriton the firm had decided to pass.

Both Spector and Schwartz were frustrated by Cayne's continuing refusal to pursue acquisitions that appeared—to the two co-presidents, anyway—to make a tremendous amount of sense. Regarding the Neuberger Berman deal, Cayne and Greenberg rejected it immediately. “They turned it down flat,” one senior Bear executive said. “They told me, ‘This will disrupt our organization. We will not let them run our PCS [private client services] business. They wanted to do nothing that would upset their world.” Schwartz looked at it more clinically, like the world-class M&A banker he was. “In the acquisition game,” someone familiar with his view explained, “there were ten things we could do out there: Two are automatic, two look pretty good, a bunch are just okay, this one's hairy. These two—Neuberger Berman and Pershing—were automatics, and if you're not going to do the automatics, why bring in the one that's a little less good than the automatics? So acquisitions were out, he realized that. Neuberger, Jimmy admits now, we should have done, and Pershing he never understood. It doesn't matter. The point was we weren't doing any of this, period.”

As ever, Cayne remained wedded to growing organically the businesses the firm was already in. “We liked our hand and we really didn't have a right to like our hand as much as we liked it,” explained one of Cayne's most senior partners. In that vein, in 2003 Cayne turned his attention to improving the firm's relatively tiny asset management business. The firm did not disclose much about this business in its financial statements since it was so small, but from the little bit of public information available, it was clear the division was not performing well under Doni Fordyce, one of the few senior-level women at the firm. The firm's assets under management had declined to $21 billion by May 31, down from $24 billion in both 2002 and 2001. The business's revenues—derived mostly from management fees—declined to $154 million in 2002 from $168 million in 2001. As for the division's profitability, the firm did not disclose this information in its public filings, but the profitability for both asset management and private client services—the brokers—had declined substantially in 2002, to $11.6 million from $128 million in 2000.
Clearly, Cayne had a problem in the business. So on June 24, he hired Richard A. Marin as the new chairman and CEO of Bear Stearns Asset Management, or BSAM, as it was known. The son of a career United Nations diplomat and a graduate of Cornell, Marin had spent twenty-three years at Bankers Trust, and then, following the firm's acquisition by Deutsche Bank in 1999, he headed up Deutsche Asset Management, with $325 billion in assets under management. Marin's arrival meant that Fordyce had been demoted to BSAM's president. Despite her public statement that “I'm looking forward to what will be a dynamic partnership” with Marin, Fordyce was not happy. She left four months later.

Marin found a business that had some good products and some good people but that had been starved for capital and management. Spector told Marin: “Bear Stearns succeeds at anything it puts its mind to. And since we haven't really succeeded at asset management, we haven't put our mind to it. We want to put our mind to it now. We want to have you come in. And we want you to grow this, grow it more quickly than it's grown before.” Marin and Spector talked about what would be reasonable metrics on which Spector could judge Marin's performance. They spoke about how both BSAM and Goldman Sachs's asset management business had both started in the same year, 1984, but that nearly twenty years later GSAM had $400 billion of assets under management and BSAM had less than $20 billion. These assets consisted of 60 percent hedge funds and 30 percent traditional asset management, with the balance a smattering of small private equity and venture capital funds that were not related to Bear Stearns's successful merchant banking fund, run by John Howard. Why couldn't BSAM be as important to Bear Stearns, they wondered, as GSAM was to Goldman Sachs? Out of this brain-storming session came the strategy known inside Bear Stearns as “10 in 10,” whereby BSAM would be 10 percent of Bear Stearns's revenues and profits by 2010. This would be the metric on which Spector would judge Marin's performance. To be sure, Marin's challenge was significant given that in 2003 BSAM was about 1 percent of the firm's revenues and a negative contributor to its profits.