Bear Stearns: Salvaging a Prudent Name

[Andy Nguyen]

Information is power and there are tons of inside information to be learned from this story. I highlighted the info that I find useful or interesting.

By LANDON THOMAS Jr.
Published: June 29, 2007
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James E. Cayne has a bellyache.

“I plan on sticking around,” said James E. Cayne, chief executive of Bear Stearns.

And it is not from the crash diet that has caused Mr. Cayne, the chief executive of Bear Stearns, to shed 20 pounds over the last year.

At Bear Stearns, the firm Mr. Cayne has worked at since 1969 and guided since 1993, the carefully honed reputation for sound risk management and cautious investing has suffered what he regards as a “body blow of massive proportion” from the near collapse of two hedge funds run by its asset management division.

“I’m angry,” he said as he took a deep puff on a freshly lit Montecristo cigar in a conference room next to his office. “When you walk around with the reputation for being the most rigorous risk analyzer, assessor, controller and that is trashed, well, you have got to feel bad. This is personal.”

In the last two weeks, Bear has found itself in a fiasco that some within the firm say is without parallel in its 84-year history.

While the unraveling of the funds is not expected to affect the bank’s bottom line, it has made the firm a potential target for regulators and class-action lawyers.

Front and center is Mr. Cayne, 73, the oldest chief executive of a Wall Street firm and now confronted with salvaging the firm’s reputation. He is a world-class bridge player who did not finish college and whose first job was as a traveling salesman selling copiers in the Midwest.

His ascent has been a result of a card player’s guile, a brilliant run trading the distressed bonds of New York City in the early 1970s and a boundless belief in his abilities and that of his firm.

“It’s an amazing story,” said Michael Ledeen, the foreign policy analyst and Mr. Cayne’s bridge partner. “He didn’t go to Harvard Business School — he was a bridge bum,” Mr. Ledeen said, and Mr. Cayne’s predecessor, Alan C. Greenberg, known as Ace, needed a bridge partner.

“Ace said come work at Bear,” Mr. Ledeen said, “and then Jimmy made a market in New York City municipal bonds and then the frog turned into the prince.”

The problems with the two funds have shaken Mr. Cayne.

“In the last 15 years, I have never walked into a room or been at a dinner party where I did not feel that when people looked at me they thought I was O.K., successful, agile,” he said. “That might have changed. I feel like people now look at me with a question mark.”

Despite his contrition, legal experts say Mr. Cayne is likely to face tough questions from regulators and lawyers for investors over how, in a firm known for its risk controls, a trader could make such a disastrous bet.

“This is a guy that is in the loop — he is an activist C.E.O.,” said Jacob Zamansky, a securities lawyer who represents individual investors. “He can’t say that he knew nothing if there is a responsibility to be on top of the different business units. The proof will be in the e-mails and the documents.”

Bear Stearns and Mr. Cayne have survived other crises. The firm has paid fines for its ties to fraudulent brokerage houses and investment firms that engaged in illegal mutual fund trading. But its scrappy disposition and a tightly knit culture that is bolstered by the 31 percent employee ownership stake have helped sustain the firm.

Until this year, the firm’s stock has outperformed its peers, in part because of a dominant position in the booming mortgage securities and hedge fund services markets and a growing recognition of its influence as a niche investment banker to companies like Cablevision, Walt Disney and Verizon.

Mr. Ledeen has written a book about the leadership lessons of Machiavelli and Mr. Cayne has devoured it.

“Jimmy saw himself in Machiavelli,” Mr. Ledeen said. “He, too, is living in a world that is very corrupt and where temptation is huge. But you have to get rid of failure and you have to punish lack of virtue ruthlessly and all the time. Jimmy does not trust second chances — if he finds someone who misbehaves he gets rid of him. Fast.”

It is perhaps this sensibility that forms Mr. Cayne’s extreme caution when it comes to putting the firm’s capital at risk. Over the years as firms like Morgan Stanley and Goldman Sachs have become more aggressive in trading their own capital, Bear has remained conservative.

But, at the Bear Stearns asset management unit, executives started an overleveraged, high-risk fund last August just before the market for subprime loans sank.

It was the kind of high-stakes bet that the firm’s own proprietary traders, wary of Mr. Cayne’s exacting eye, would never have made.

And while Bear Stearns has said that the asset management unit was separate from the firm’s securities division, questions remain as to why there were not adequate controls in place.

The thought of such an overleveraged bet now angers Mr. Cayne, who is the firm’s largest individual shareholder with a stake that at the stock’s peak was $1.2 billion.

“I would have bet against this occurring at Bear Stearns, ” he said.

That such an initiative and the attendant meltdown occurred in a business that represents but 6 percent of the firm’s revenues have driven senior Bear executives to distraction.

The immediate onus has fallen on the funds’ manager, Ralph R. Cioffi, and the head of asset management, Richard A. Marin, neither of whom is expected to get the benefit of one of Mr. Cayne’s rare second chances.

But the business also reported to Warren J. Spector, the longtime co-president, and people inside the firm said he, too, was shouldering part of the blame.

Mr. Cayne declined to comment on who should be held responsible. But he did say that “there is a lot of pain here.”

Bear and Mr. Cayne assumed responsibility for the funds’ demise by providing a $3.2 billion line of credit, a move that drew the approval of Mr. Cayne’s peers on Wall Street. Still many lenders to the hedge fund wondered why the firm did not act sooner, perhaps in April when it became clear that the securities were losing value.

With its expertise in the mortgage market, lenders said the firm should have recognized a problem when these highly complex securities began to trade below their par value in the spring.

Mr. Cayne would not discuss in detail the specifics of the fund’s troubles, citing client confidentiality.

Nevertheless, the view within the firm is that Bear had no legal obligation to rescue the funds and that the loan agreements made clear that the lenders were transacting with the two funds and not Bear itself. The firm decided to make the secured loan when it became clear that the funds were near collapse and that Bear’s image was being damaged.

As for whether the recent turmoil might cause Mr. Cayne to step down and pass the baton to one of his co-presidents, either Mr. Spector or Alan D. Schwartz, who oversees investment banking — do not bet on it.

“I plan on sticking around and I will leave when these guys want me to leave,” he said.

Mr. Cayne shows no signs of slowing. He has cut out red wine, bacon and salmon for breakfast and the late-night deliveries from Bobby Van’s steakhouse as part of a regimen to lose weight. He has a tan from weekends at his beach house on the Jersey Shore and his youthful demeanor belies his age. He is a fan of the music of the Norwegian pop star Sissel and loves any movie that stars Halle Berry.

As for any plans he might have to put the firm up for sale, he calls such talk old and repetitive and says Bear Stearns is well placed to survive as an independent entity.

All the same, the firm remains underexposed to strong growth trends overseas and overexposed to the slumping mortgage market, which contributed to a 10 percent drop in net income in the first quarter.

“The firm is doing really well, and we are expanding in Asia and Europe,” he said. “We have a phenomenal franchise.”

Leaning back in his chair, Mr. Cayne puts his foot up on a nearby chair and sighs. A man of blunt emotions, he generally feels better after a good old-fashioned venting.

No doubt, for the short term, things seem bad. Regulators are sniffing around, editorial writers are wagging a collective finger at him and, to top it all off, the head of his asset management unit has a blog. <-- This is funny :D

But Mr. Cayne has experienced worse: during his days as a traveling salesman he almost died when his car hit a utility pole; he has seen a bankrupt New York City; and on the day the market crashed in 1987 he remembers walking on the floor of the stock exchange and seeing Bear’s stock trading at $8 with no buyers in sight.

But Bear continues to be Bear.

“The playing field is getting small,” he said. “There are four giants and us. We are a survivor.”