By Kate Kelly
Penguin Press, 2008
Kate Kelly’s fast-paced Street Fighters chronicles Bear Sterns’ final 72 hours, employing this three-day window to examine Bear’s history, culture, and the financial missteps leading to the organization’s ultimate demise.
Kelly does not frame the events of March 2008 as some inexorable economic forces suddenly pounding the once-proud, 85-year-old Wall Street firm into collapse. Rather, her insights challenge readers to wrestle with the larger issues of corporate leadership and governance frailties that left the 14,000-member firm ill-prepared to adapt to a changing environment. She draws readers intimately into the Federal Reserve’s and Treasury Department’s dilemma of balancing moral hazard (i.e., “… giving taxpayers the impression that poorly managed companies would be bailed out by the government…”) versus systematic risk (i.e., concern that Bear’s bankruptcy would cause “… a series of dominos to fall after it-potentially taking down most or all of Wall Street”).
Kelly rightly reminds readers of Bear’s proud tradition as a “lean” and “scrappy” organization that survived the 1929 crash without employee layoffs and that guarded carefully against outsized risk. Alan “Ace” Greenberg, CEO from 1978 to 1993, was known for tight expense controls, troubleshooting risks, and, most importantly, cutting losses early. Greenberg challenged his organization: “It is up to all of us to fight our unrelenting enemies-complacency, over-confidence, and conceit.”
Along the way, however, Bear’s leadership changed profoundly. James (“Jimmy”) Cayne, named as Greenberg’s successor in 1993, was described by an outside director as conducting “perfunctory” board meetings. Internally, senior management reportedly believed that Cayne “… lacked interest in details.” Cayne’s extended absences attracted public notoriety when the Wall Street Journal reported that during Bear’s initial summer 2007 mortgage crisis, Cayne traveled to a Nashville bridge tournament, maintaining only limited cell phone and email communication in the face of this turmoil.
In January 2008, Alan Schwartz replaced Cayne as CEO; he served until J.P. Morgan’s Federal Reserve-sponsored takeover of the company approximately two months later. As March 2008 opened, Schwartz eagerly awaited the opportunity to report expected first-quarter earnings of approximately $1 per share, following Bear’s loss in the prior quarter. Schwartz envisioned his announcement restoring investor and client confidence, but Bear’s cash hemorrhaging in early March permanently preempted this anticipation.
Clearly, the 2007 and 2008 economic environment deteriorated for highly leveraged firms operating in mortgage securities markets. But early warning signs did flash.
Bear closely witnessed, but ominously chose not to participate in, the 1998 rescue of Long Term Capital Management, another highly leveraged organization believed to pose systematic risks to the banking industry. In summer 2007, Bear needed to provide cash rescues for two mortgage-related funds the firm managed. Following the mid-2007 problems, key management members urged leverage reductions, but these conservative voices went unheeded. And when opportunities arose for additional outside financing in early 2008, Schwartz dismissed these proposals, preferring to wait for better offers.
The epilogue of Street Fighters includes Schwartz’s astonishing April 3, 2008, testimony to the U.S. Senate Banking Committee: “I just never frankly understood or dreamed that it could happen as rapidly as it did. I just simply have not been able to come up with anything…even with the benefit of hindsight, which would have made a difference.”
Kelly’s tale of Bear Sterns’ demise motivates organizations to carefully scrutinize the strengths and weaknesses of their leadership teams and encourage vigilance regarding any deterioration in the operating environment.
As taxpayers and private citizens, many readers may reflect more deeply on the long-term implications of the government’s March 2008 decision to ignore moral hazard and instead deploy Federal Reserve resources to prevent Bear Sterns’ bankruptcy, the first major step in what has now become a litany of government interventions cushioning selected sectors from economic fallout. In the long run, will the Federal Reserve and Treasury Department prove more capable than Long Term Capital Management or Bear Sterns in managing an over-leveraged balance sheet?
The final chapter on moral hazard versus systematic risks is still unfolding.