House of Cards (73 page)

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FTER HIS MEETING
with the Bear Stearns lawyers, Sharon went to see Cayne for his scheduled appointment. He wanted to show Cayne the monthly statements from the hedge funds. “Have you ever seen these things?” Sharon asked Cayne. “He said, ‘No. What are they?' I said, ‘These are the monthly statements. You should look at these things.' He said, ‘I don't want to see this stuff.' I said, ‘You should let me read you some of the things that Ralph has been telling people.' I started reading: ‘We expect delinquencies to rise. We expect housing values to decline,' the whole thing. I explained to him the types of clients that I had that are
in this thing, that these guys have armies of lawyers that are on retainer for their businesses, and that we have to do something about this. I was there with him for about forty-five minutes going over this stuff. He said, ‘You know, they're all down in the auditorium right now.' I said, ‘Who's in the auditorium?' He said, ‘All the creditors, and we were making an offer to them right now. But I wouldn't take it if I was them.' I said, ‘What's the offer?' He said, ‘No margin calls for a year, and I think the firm was offering to put $1 billion up somehow.’”

While Sharon was talking to Cayne, Steve Begleiter walked into the office. Sharon asked him if he had seen Cioffi's monthly reports and then, with a yellow marker, Sharon highlighted for Begleiter the misleading collateral summary, specifically about how the funds had invested only 6 percent of their assets in subprime and how Cioffi had said he saw “this meltdown coming.” They then discussed how Cioffi's summaries made it clear that he had supposedly put much of the funds' money into asset-backed securities—credit cards and auto loans—that would be considered much safer than the CDOs where Cioffi had actually invested the funds. “I had always been under the impression that when I saw the collateral summary, ‘Wow! Ralph is hiding in the gold,’” Sharon told Cayne and Begleiter. After Sharon finished sharing the documents with them, Cayne said to him, “Look, if there's fraud, we're gonna pay.” Cayne also wondered why “we pay lawyers all kinds of money to write these prospectuses and explain the risks to people,” and then repeated, “But if there is fraud, we're gonna pay.” Then, according to Sharon, Cayne turned around and yelled to his longtime assistant, Suzette Fasano, to get Rich Marin on the phone. “You better be prepared to say something at the [senior managing directors'] meeting tonight about the status of the hedge funds,” Cayne told Marin.

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ERY
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TUPID
D
ECISION

n the end, Cioffi's June 18 proposal flopped. Many of the repo lenders ignored Cioffi's plea for more time and an orderly liquidation and ran for the exits as the fire raged. Merrill Lynch reversed itself again and on June 19 decided to seize and then sell into the market $850 million of
its collateral from the hedge funds, more than double its initial plan. But when buyers were few and pushed for a low price, Merrill ended up keeping most of what it had seized rather than sell it for a low price and taking the markdowns to the rest of its vast portfolio of mortgage securities. “They would have locked in a lot of losses for themselves and a large slug of their client base by jamming bonds into the market,” a hedge fund manager told the
New York Post
about Merrill's decision. Merrill's decision to seize its collateral struck many on Wall Street as highly unusual. “I've never seen a dealer seize another dealer like that,” an unnamed trader told
National Mortgage News
. There was also the inevitable comparison made to Long-Term Capital Management and how no one on Wall Street was there to help Bear Stearns in its hour of need. “They were all friends with Bear Stearns when they thought the spreads were huge,” Anthony Sanders, a former mortgage bond research analyst at Deutsche Bank, told Bloomberg. “Now that the market has turned, Bear's standing there like the lone grizzly. They looked at these high yields, this growing market, and they forgot the basic concept of risk and return. They got caught drinking their own Kool-Aid.”

Cioffi also spent Tuesday negotiating bilateral agreements with both Goldman Sachs and Bank of America. The agreements allowed these firms to be repaid $2.25 billion in an effort to “help stave off painful ripple effects in the broader market for mortgage-backed securities,” the
Journal
observed. Then both Lehman Brothers, with close to $650 million in repo loans to Cioffi's funds, and Credit Suisse, with $263 million in exposure, seized their collateral, too, and sold it into the market—before Merrill Lynch—with Lehman reportedly getting 50¢ on the dollar. JPMorgan, with $558 million in repo loans to the funds, intended to seize its collateral also but decided instead to engage in a bilateral negotiation with Cioffi along the lines of what Goldman Sachs and Bank of America did. According to the
New York Times,
JPMorgan was able to sell $400 million of its collateral back to Cioffi for cash, although the price of the sale was not disclosed. One hedge fund executive who had looked at Cioffi's hedge fund positions told the
New York Post,
“They haven't collapsed in price because they are often mismarked or just don't get traded. That is going to change in a big way today at 4
P.M.
, when the [Merrill] auction ends.”

Even by the generally chaotic standard that passes for the norm at a Wall Street investment bank, June 2007 at Bear Stearns was a particularly frenetic month. As trouble was brewing at the hedge funds, Cayne, Molinaro, and Robert Upton, Bear's treasurer, had invited a small group of executives from Moody's, the rating agency, for lunch in the executive
dining room. The idea had been to try to convince Moody's to begin thinking about upgrading Bear's credit ratings. A better credit rating lowered the cost of the firm's borrowing and was, according to Upton, “a competitive weapon for derivatives issuance, in particular, but it just would be a good thing to keep going north in the ratings.” It was meant to be “a love-to-love lunch with Jimmy,” Upton said, “and Sam and I had some key points that we wanted to make about the business.” But because of the ongoing negotiations with the repo lenders, Molinaro kept getting pulled away from the lunch by frantic calls about the hedge funds. Upton worked hard to cover for Molinaro. In the middle of his comments about the relative strength of the firm's various businesses, the Moody's team kept returning the discussion to the hedge funds. Upton said it became embarrassing. “It was almost comical because you're a CEO of one of the most successful Wall Street firms, the hedge funds are blowing up, and he wasn't terribly engaged in that discussion on the phone— all the calls were to Molinaro, and he was running in and out of the room,” Upton said. “God bless Jimmy, he talked about people and stories. But at this very critical juncture in the firm's history—[with] what ultimately became the first in a series of death blows—while we were trying to deflect concern from rating agencies and ultimately convince them that not only were we healthy and okay but that we were an improving credit, the CEO and the guy who was supposed to have basically control of understanding what was going on everywhere just completely missed the boat. He didn't talk about anything other than when he had lunch with Walter Shipley from Chemical Bank. It was rather telling about what I think was going to happen over the course of the next nine months.”

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S THE FIRST
margin calls came into the hedge funds during and after the creditor meetings, there was a “bit of a game of chicken” going on, according to one participant, whereby the two sides would argue about the valuation of the collateral and just how much additional margin was needed. After a few days of this macho behavior, one repo lender to the fund approached BSAM directly about negotiating to buy back its collateral, allowing the hedge funds to get the cash they needed and the lender to get its collateral back at a price it thought it could make money at whenever it chose to sell the securities in the market. On the advice of Blackstone, BSAM informed all the lenders about the opportunity for bilateral negotiations.

“Suddenly everybody wanted to do a deal, including Merrill,” one Bear executive said. “All these bilateral deals start getting negotiated. The problem is the bilateral deals are being cut at levels that are below
book value, so every time we do one it nips away at the book value. There are so many moving parts—derivatives, which are very complex to value, and cash instruments that are very complex in their own right, and whole portfolios that have hundreds of millions of dollars and sometimes a billion dollars. All of that coming into the thin neck of the funnel of Ralph and Matt trying to do the valuations—you can imagine what kind of a shit show this was.” Another bottleneck came when Marin would not allow Cioffi to agree to any bilateral deals until both BSAM and Bear Stearns had signed off. That brought the executive committee into the mix. “Now Marin's talking to Warren all day long and Warren's talking to Ralph all day long,” said one observer of this bit of corporate theater. As the demand for one-off deals from the repo lenders escalated, Spector decided that Marin and Cioffi could no longer do the work themselves and decided to get his lead trader, Tommy Marano, involved.

Marano, an extremely experienced trader and Grateful Dead lover, moved over to help manage the unwinding of the High-Grade Fund. That left a big hole in the fixed-income department but was thought to be necessary under the circumstances. Marano was going to work with Paul Friedman, whom Spector had already asked to go over to the funds. The firm put out an announcement that Marano would be seconded to the hedge funds. The firm also asked Mike Alix, the firm's chief risk officer, to oversee BSAM. The firm furthermore announced that Marin would take “a stronger role” in running the two hedge funds, although Cioffi would still remain involved.

Then there was the problem of the intense pressure on the clerks, who worked for the funds, to be able to quickly and accurately reconcile the daily cash positions with all the transactions happening so quickly. “Under normal circumstances, they're perfectly competent to do that,” said a BSAM executive. “It's like an airline pilot who suddenly is in a dogfight. It's outside their range of experience. They don't know how to deal with all of the variables that come into play. Just trying to keep up with it in a twenty-four-hour day had proven to be impossible.” The pressure on everyone was mounting. “This is an unusual time, the shit is flying in every direction,” said one executive. “The people are trying to fend off creditors, and when you're trying to fend off creditors and everybody's trying to get a piece of you and you're trying to do this in an orderly manner, people will call up and say, ‘You didn't call me back. I called you an hour ago.' Well, he doesn't know that you've had fifty phone calls in that hour and you're trying to do a reconciliation. It was a nightmare.”