The Lessons of the Bear Stearns Failure

William D. Cohan knows Wall Street from the inside out. A former investment banker at Lazard Freres, Cohan a few years ago hung up his pin-striped suits for more casual attire and returned to his first career: journalism. His first book, "The Last Tycoons," an insider's look at the transformation of modern Wall Street as seen through the eyes of Lazard, pulled back the curtain at the distinguished firm. In the spring of 2008, when the failure of Bear Stearns kicked off a raging, global financial crisis, Cohan knew he had a subject for his second book. "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street" provides a fly-on-the-wall view of the history of Bear and its ignominious end. He spoke with NEWSWEEK's Daniel Gross. A podcast of their conversation can be heard here. Excerpts:

Gross: Bear Stearns was the fifth-biggest investment bank but not a member of the elite. Was it always seen as an outlier on Wall Street?
Cohan: Yes, Bear Stearns made itself a bit of a renegade. There's this weird hierarchy that exists. A compendium of elite institutions—Goldman Sachs and Morgan Stanley—being at the top. They were the white-shoe firms that got the graduates from Harvard and Yale and Princeton. Bear Stearns was very different.Sy Lewis, who ran Bear Stearns from the late '30s till his death in 1978, was a semiprofessional football player, sold shoes and spent one semester at college. Ace Greenberg, who succeeded him, was in that same mold.And Jimmy Cayne, Bear's last CEO, was, too. They had a philosophy at Bear Stearns as wanting poor people who were striving to be rich. They didn't care where you went to school or even if you graduated.

Can you talk a little bit about Ace Greenberg, who was the spirit and CEO of the firm and also quite a character?
Sy Lewis, Ace Greenberg and Jimmy Cayne were all characters. The book is called "House of Cards," which is a double-entendre on their phenomenal bridge-playing skills; they were probably playing bridge a little bit too much when they should have been focusing on the business. Ace Greenberg was the son of a Midwestern clothing merchant, and he brought this homespun Midwestern sensibility with him to Bear Stearns. They didn't take big risks at that time. He famously wrote these memos that have been packaged up into a little book that encouraged people to reuse paper clips and rubber bands, and it's that sort of philosophy that ran the firm and made it very profitable. And then in 1993, Cayne deposed him, so you had a very different strategy.

Jimmy Cayne is, in many ways, the center of this book. As a reporter, I've had a chance to interview a lot of CEOs who are all polished sophisticates. Cayne is not of that world.
No, he's not of that world at all. He obviously was a perfect candidate for Bear Stearns. I can see why he got to the top. But on the other hand, he's got this roguish charm. He prides himself on reading people very well and he knows where the bodies are; he knows how to count votes and he's very political … not in a negative connotation. But he knows what he has to do to accomplish what he wants to. When he became CEO in 1993, there was an awful lot of talent at Bear Stearns. Cayne just unleashed this incredible creativity and talent, and the firm's profitability just skyrocketed.The stock went from $30 a share, when he came on, up to $172.69 at the peak in January of 2007. Nobody questioned his management style, which stayed the same. He still played bridge and golf and had his friends on the board. Nobody questioned that until soon after things started to come apart in the spring of 2007.

There's a sense that at many firms, the top executives literally didn't understand some of the securities they were buying and selling, like CDOs. Was that true here?
Cayne tells me that he didn't understand the risk that was inherent in these securities and the business plan that Bear had adopted. I believe him, but it makes you scratch your head. He's getting paid $30 million a year, year after year, enjoying all the fruits of this risk-taking, but he now claims he doesn't understand how all that happened? Why did the board of directors of this company have somebody as a CEO who didn't understand this?

When two hedge funds managed by Bear Stearns blew up in the summer of 2007, it seems like Cayne's reaction was similar to the one he had when Long-Term Capital blew up in the late 1990s: to hell with our reputation, we're not going to bail other investors out.
In 2007, he was talking about bailing out the overnight lenders to the hedge funds. And he argued vociferously not to do it. He got overruled. Ace Greenberg basically insisted that their reputation was on the line. The problem was that when Bear liquidated the hedge fund, it took control of collateral that creditors had held. A lot of it was CDOs. And those securities quickly became almost worthless--causing the big write-off they had in the fourth quarter of 2007, which caused Bear to take the first loss in its history.

That would have seemed a logical time to take a step back and dial down the amount of leverage  Bear was using. Did nobody internally stand up and say that in the summer or fall of 2007?
Ironically, the closest anybody came to doing that was Jimmy Cayne. He may not know why he didn't want to do it, but he got a gut reaction that it was too much to take on. And they had many opportunities starting in the summer of 2007 to raise capital, but never did. They only wanted to take new capital if they saw it had a strategic benefit. In March 2008, when they went under, they had $18 billion in cash, but every night they borrowed $75 billion from overnight lenders. It had to be renewed every day. And unfortunately it gave these overnight lenders a vote every night. It's like if you voted for President Obama every day, and one day you decide that you don't like him, and you vote him out of office. That's what happened to Bear.

Looking back, is Wall Street a better place or a worse place with Bear gone?
Well, it's certainly different. Bear's downfall was symptomatic of what happened on Wall Street, which rewarded this crazy behavior without having accountability whatsoever. There are no big independent investment banks anymore. The compensation has come way down. Will it return? Human nature is such a powerful force. A month after I came to Wall Street in 1987, there was a crash, and I saw grown men cry, vowing that they'd never repeat what had been done. Twenty-two years and five financial crises later, we're right back at it again.

As you talk to the protagonists, a sense emerges that they are simply fatalistic about Bear's demise and all the damage it created.
Yes, that was quite disappointing. Ace Greenberg was extremely cavalier about it. Jimmy Cayne wasn't quite as cavalier, but he was matter-of-fact about it. Alan Schwartz, who served as CEO briefly in Bear's final months, seems to me to have taken it a lot harder. I'm glad somebody is trying to come to grips with what happened here. 

With Kiki Von Glinow and Anita Kirpilani

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