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Bear Market’s First Bagged Bear

A riveting tale of hubris and wretched excess.

By 3.26.09

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House of Cards: A Tale of Hubris and Wretched Excess on Wall Street
by William D. Cohan
(Doubleday, 468 pages, $27.95)

If the August 2007 implosion of the subprime mortgage lending market signaled the impending burst of the housing asset bubble, the March 2008 collapse of the old-line investment banking firm Bear Stearns & Co. heralded the stock market crash and global financial crash of 2008. Cohan is an ex-investment banker who previously published a history of the investment-banking firm Lazard Freres (best known for partner Felix Rohatyn, architect of the 1975 New York City financial bailout). He has written a riveting, richly detailed book that provides insights useful for understanding how we got into the financial mess we find ourselves enmeshed in, the first step in figuring how we might extricate ourselves from economic purgatory.

Founded in 1923, the firm prospered under the guidance of three dynamic leaders. First, in 1933, came Salim (Cy) Lewis, who made a post-Depression financial killing for the firm by buying for a song millions in railroad bonds that were worthless when government-owned during World War II but when privatized, became hugely valuable. Lewis in the 1950 was, along with Gustave Levy of Goldman Sachs, co-pioneer of proprietary "block" trading, in which the firm bet huge sums of its own capital on a daily basis, trading in and out of huge blocks of stock bought and sold by financial institutions, pension funds and the like.

Second, in 1949, came Alan (Ace) Greenberg, a legendary trader with ice water in his veins, who expanded the edifice built by Lewis and took Bear public in 1986, gaining access to vast pools of public capital, while transferring most associated financial risk from the firm's partners to the shareholding public. A fanatical cost-cutter, Greenberg urged his employees to recycle envelopes and take paper clips off correspondence they received. Third, in 1969, came Jimmy Cayne, a hustling middle-class Midwesterner who combined natural salesman skills with financial acumen and world-class bridge skills that gave him access to some of his biggest clients. Cayne and Greenberg would live to see the firm collapse, in the process costing them nearly all their surviving investment in the firm.

The firm's trading horizon was day by day, with rejection of planning, prediction or projection. You bought, sold, and did not mire yourself in bad positions. Greenberg never got angry with his traders for taking a loss, only for whatever he perceived as sloppy. Said Greenberg, when asked what makes for a great trader:

Oh, I don't know. I think the important thing in the securities business is just taking losses. Saying you are wrong. If you own securities, and if you make a mistake, you can take a loss. If you make a mistake in real estate, you have to buy a for-sale sign. And I just think the ability to take a loss and say you are wrong is something you should do.

Greenberg's sang-froid paid off during the Crash of 1987, when a 22.6 percent single-day plunge wiped out $500 billion of market value and two-thirds of Bear's $24B market cap. Greenberg saw the debacle as a fantastic buying opportunity. To rally his trader troops, he stood up in the trading room during the pandemonium and causally swung a golf club, saying he might go play golf the next day.

A fixed-income powerhouse, Bear entered the mortgage-backed securities market in 1986 and quickly became a major player. It rode the bubbles of the 1990s and 2000s blissfully unaware, but in good company. On February 28, 2007, Federal Reserve Chairman Ben Bernanke testified to Congress that he did not see a "housing downturn" as a "broad financial concern or a major factor in assessing the state of the economy." Six months later the subprime market imploded. In 2006 Bear realized that diversification supposedly embedded in securitization of subprime mortgages was fiction: the market was mostly NINJAs (No Income, No Job/Assets). By mid-2007 Bear's $12B of equity was leveraged 44 times, versus $525B of assets.

Treasury Secretary Hank Paulson and Fed Chairman Bernanke worked to rescue Bear, lining up, after much cajoling, a reluctant JP MorganChase whose dynamic CEO, Jamie Dimon, put together a bid within two days. Dimon was prepared to pay $10 per share at a time when Bear's stock was carried on the books at $84 per share. But Paulson, fearing moral hazard if Bear's shareholders got $10, forced the price down to $2, nearly 99 percent below Bear's $172.69 per share peak. Yet Dimon's star lawyers made a huge blunder, drafting a key clause poorly, thus giving Bear license to shop for a higher bid without losing JPM's bid, for up to one year. Fortunately for Dimon, no one else was interested in buying the wounded firm, whose dense contractual interlocking with over five thousand firms worldwide created an accounting and investment fog that could obscure countless billions in financial perfect-storm surprises.

But if Bear failed, so did the federal government. When on the Ides of March Bear was stabbed multiple times by suspicious counterparties seeking more added financial assurance than Bear's cash could meet, Bear turned to the Federal Reserve. The Fed authorized a revolving credit line -- but it could not, for administrative reasons, be activated until March 27. By then Bear was long gone.

When Lehman Brothers went Bear's way six months later, the feds followed the script for Bear, except that they could not find a buyer for Lehman and would not do anything like the $29B loan they gave Bear's buyer. Lehman sank, and sent a cascade shock though the global financial system, causing a near core meltdown. AIG and Washington Mutual imploded; Wall Street's last two investment banks, JPM & Goldman Sachs, converted to commercial banks; Congress passed the first of several monster rescue packages; the Fed pumped several trillion into the economy and Treasury stumbled around in search of a plan to save zombie banks.

The author sums up the deluge that followed by quoting a Wall Streeter: ""But, in truth, it was a team effort. We all f%^&*d up. Government. Rating agencies. Wall Street. Commercial banks. Regulators. Everybody."

It took Rome 224 years after Caesar's murder in 44 BC to slide, upon the death of Marcus Aurelius in 180 AD, into irreversible decline. Born in 1790 under the fabled New York Stock Exchange buttonwood tree, Wall Street expired in a mere six months, dead at age 218. The cause of death, as Cohan's book shows, was epic hubris. Now America's economic and financial future is in the hands of the federal government, under a President and Congress whose hubris trumps Wall Street's, and is combined with an ignorance no trader could survive with for a single week.

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About the Author

John C. Wohlstetter is a senior fellow at the Discovery Institute and London Center for Policy Research, author of Sleepwalking With the Bomb, and founder of the issues blog Letter From the Capitol.