Tuesday, May 27, 2008
The Fall of the Bear
Today's WSJ ($) has the first in a three part series on the ignominious end of Bear Stearns. This will eventually be spun into a Wall Street thriller, akin to Ken Auletta's outstanding tale Greed and Glory on Wall Street: the Fall of the House of Lehman. Auletta's work should be required reading for anybody interested in learning about the innards of Wall Street and some of its history.
Each of the these stories has its similar characters, and Lew Glucksman and Jimmy Cayne may be compared someday as the trading leaders who let their business slip away. And there will be players in the book -- like Jimmy Robinson, Peter Cohen, Pete Peterson, Steve Schwartzman and Dick Fuld -- who emerge as larger players in subsequent histories (American Express, Blackstone and the newer Lehman). But the Bear story is unique for this moment. Why did it happen?
Well, the shared character trait of arrogance runs across all these stories. But there is a particular failure to the governance of Bear Stearns -- unlike the old Lehman which was a private partnership -- which exacerbated the arrogance of an individual and turned it into a tragic institutional flaw.
When, in the late summer of 2007 the Bear Stearns Board had the key, life or death decision to make as to which of its leaders it could rely on to take the firm into the future, they made the wrong choice. They may not have recognized it at the time. They may not have appreciated the gravity of the moment. They only came to acknowledge the failure later, when they had to make another change at the top mid-crisis. And now they had fewer, and worse choices. This sealed the Company's fate, and condemned it to JP Morgan's control on exceptional terms; terms devastating to Bear's shareholders.
What am I talking about?
Bear's board, in this author's (that's me) opinion, fired the wrong guy in the summer of 2007. They fired Warren Spector - the head of Bear's trading divisions. Jimmy Cayne protected his job and position as CEO by pinning responsibility for Bear's problems on Spector. But Spector was the highest IQ player at Bear equipped with the experience and acumen to deal with the Firm's trading and associated financial and liquidity issues. Cayne was arrogant and past his best days. But the Board failed this first and most crucial test. They picked the wrong guy.
Markets were quick to make clear that the Cayne choice was a poor one. And as the Wall Street Journal story makes clear, it only took a few months for the pressure to build too replace Cayne. But now, the only clear internal successor was Alan Schwartz. What was wrong with him? He had completely the wrong training and experience to deal with the balance sheet and liquidity crisis - he was an investment banking business generator and merger professional. He had zero trading experience. When named CEO, I figured his job would be to make a deal, raise money, sell the bank. Fine I suppose, but it's hard to sell a burning house. You need to put out the darn fire, and this guy hadn't worked a hose before. Forget the fact that he and the Board didn't smell smoke or see flames until they were engulfed.
Bear may ultimately have succumbed anyway to the overwhelming balance sheet with which it was faced by the end of 2007. But the Board's key management decisions were failures. It may be that more experienced and skilled leadership trained to address the balance sheet challenges the Firm faced could have allowed Bear to live to fight another day.
One such example -- but which happened in the private company format -- was Goldman Sachs at year end 1994. In that fateful year, Goldman blew up. It suffered the same pressures we are currently witnessing besiege other firms, just from different sources. In 1994, the losses stemmed from the substantial rise in rates (again triggered by Fed contraction), the attendant fall in Treasury prices and widening of credit spreads.
Faced with an effective loss to the General Partners and therefore an extremely leveraged balance sheet, Goldman made management changes and raised capital. And, as a private company, this financial crisis would have been personal and terrifying. As to the former, then CEO Steve Friedman stepped down (of his own accord, apparently due to the health strain put upon him by the pressure associated with the crisis), and the Firm's management committee named John Corzine the new CEO, and anointed Hank Paulson President and COO. To complete the imperfect analogy, Corzine was the equivalent of Bear's Spector, the head of Fixed Income (i.e. author of the losses), and Paulson was, like Schwartz, the Head of Banking. The difference was Goldman's Cayne, Steve Friedman, got out of the way, and let the younger, more effective trader, Corzine address the Firm's troubles without remorse. Though Corzine did lead the offending division, he was more capable of harnessing that group's capabilities to rebalance the Firm's capital -- something with which Paulson, like Schwartz, would likely have struggled.
Goldman also tapped its existing private Limited Partners -- from whom they had first raised capital in 1986 -- to reinvest a portion of their profit distibutions from the prior 8 years and buy more of the Firm. Sumitomo and Bishop Estate's renewed capital commitment to Goldman ensured confidence in the Firm's longevity. Goldman managed to achieve a successful management transition which both Bear and Lehman before it had failed to devise. At the moment of truth, Lehman and Bear management and governance failed and Goldman's did not.
There are so many human and commercial lessons about hubris and culture and confidence and so forth, but I will let that rest. For now.
Each of the these stories has its similar characters, and Lew Glucksman and Jimmy Cayne may be compared someday as the trading leaders who let their business slip away. And there will be players in the book -- like Jimmy Robinson, Peter Cohen, Pete Peterson, Steve Schwartzman and Dick Fuld -- who emerge as larger players in subsequent histories (American Express, Blackstone and the newer Lehman). But the Bear story is unique for this moment. Why did it happen?
Well, the shared character trait of arrogance runs across all these stories. But there is a particular failure to the governance of Bear Stearns -- unlike the old Lehman which was a private partnership -- which exacerbated the arrogance of an individual and turned it into a tragic institutional flaw.
When, in the late summer of 2007 the Bear Stearns Board had the key, life or death decision to make as to which of its leaders it could rely on to take the firm into the future, they made the wrong choice. They may not have recognized it at the time. They may not have appreciated the gravity of the moment. They only came to acknowledge the failure later, when they had to make another change at the top mid-crisis. And now they had fewer, and worse choices. This sealed the Company's fate, and condemned it to JP Morgan's control on exceptional terms; terms devastating to Bear's shareholders.
What am I talking about?
Bear's board, in this author's (that's me) opinion, fired the wrong guy in the summer of 2007. They fired Warren Spector - the head of Bear's trading divisions. Jimmy Cayne protected his job and position as CEO by pinning responsibility for Bear's problems on Spector. But Spector was the highest IQ player at Bear equipped with the experience and acumen to deal with the Firm's trading and associated financial and liquidity issues. Cayne was arrogant and past his best days. But the Board failed this first and most crucial test. They picked the wrong guy.
Markets were quick to make clear that the Cayne choice was a poor one. And as the Wall Street Journal story makes clear, it only took a few months for the pressure to build too replace Cayne. But now, the only clear internal successor was Alan Schwartz. What was wrong with him? He had completely the wrong training and experience to deal with the balance sheet and liquidity crisis - he was an investment banking business generator and merger professional. He had zero trading experience. When named CEO, I figured his job would be to make a deal, raise money, sell the bank. Fine I suppose, but it's hard to sell a burning house. You need to put out the darn fire, and this guy hadn't worked a hose before. Forget the fact that he and the Board didn't smell smoke or see flames until they were engulfed.
Bear may ultimately have succumbed anyway to the overwhelming balance sheet with which it was faced by the end of 2007. But the Board's key management decisions were failures. It may be that more experienced and skilled leadership trained to address the balance sheet challenges the Firm faced could have allowed Bear to live to fight another day.
One such example -- but which happened in the private company format -- was Goldman Sachs at year end 1994. In that fateful year, Goldman blew up. It suffered the same pressures we are currently witnessing besiege other firms, just from different sources. In 1994, the losses stemmed from the substantial rise in rates (again triggered by Fed contraction), the attendant fall in Treasury prices and widening of credit spreads.
Faced with an effective loss to the General Partners and therefore an extremely leveraged balance sheet, Goldman made management changes and raised capital. And, as a private company, this financial crisis would have been personal and terrifying. As to the former, then CEO Steve Friedman stepped down (of his own accord, apparently due to the health strain put upon him by the pressure associated with the crisis), and the Firm's management committee named John Corzine the new CEO, and anointed Hank Paulson President and COO. To complete the imperfect analogy, Corzine was the equivalent of Bear's Spector, the head of Fixed Income (i.e. author of the losses), and Paulson was, like Schwartz, the Head of Banking. The difference was Goldman's Cayne, Steve Friedman, got out of the way, and let the younger, more effective trader, Corzine address the Firm's troubles without remorse. Though Corzine did lead the offending division, he was more capable of harnessing that group's capabilities to rebalance the Firm's capital -- something with which Paulson, like Schwartz, would likely have struggled.
Goldman also tapped its existing private Limited Partners -- from whom they had first raised capital in 1986 -- to reinvest a portion of their profit distibutions from the prior 8 years and buy more of the Firm. Sumitomo and Bishop Estate's renewed capital commitment to Goldman ensured confidence in the Firm's longevity. Goldman managed to achieve a successful management transition which both Bear and Lehman before it had failed to devise. At the moment of truth, Lehman and Bear management and governance failed and Goldman's did not.
There are so many human and commercial lessons about hubris and culture and confidence and so forth, but I will let that rest. For now.
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