FINANCE: House of Cards: How Wall Street's Gamblers Broke CapitalismBy William D CohanAllen Lane, 468pp. £25
WE HAVE been led to believe, post Enron, that US governance is second to none. So it is surprising to read that the first the board of directors knew of Bear Stearns’ terminal difficulties was three days before agreement was reached to sell the firm to JP Morgan at a knock-down price of €2 per share. A mere 14 months earlier, the shares had traded at a high of $172.69. This seismic economic event had reverberations around the world, including Ireland. It led the following day to “the St Patrick’s Day massacre”. Shares on the Irish stock market lost €3.5 billion, while Anglo Irish Bank shares plunged 15 per cent in value.
Three days earlier, a telephonic board meeting was hastily convened by Bear Stearns’ chief executive. The 74-year-old board chairman (and recently retired chief executive), Jimmy Cayne, was playing bridge in Detroit. Neither he nor any of the non-executive directors had any advance warning that the firm was imploding. The board authorised management to file for bankruptcy, if no alternatives to saving the business could be found. Extraordinarily, in the middle of the meeting, the chairman left the phone to return to his bridge tournament, without telling his fellow directors.
This book chronicles the 10 frenetic days leading to the acquisition of Bear Stearns by JP Morgan after 85 years in business, and examines the multitude of reasons for its demise.
During six of the 10 days, Bear Stearns’ chief executive was in Florida for golf and networking with clients. He only returned to New York three days before the firm was sold to JP Morgan. The chairman of the board did not return to New York from his bridge tournament until the night before.
BEAR STEARNS HADa unique corporate culture and was a bit of a black sheep on Wall Street. Unusually for an investment bank, it did not value reputation. Profitable business won out over reputation. A large sign hung outside the trading room: "Let's make nothing but money." Staff got promoted by making money. The more you made, the higher the promotion.
Another obsession was cost control. A very tight lid was kept on expenses, with the chief executive writing memos to staff on the use of paperclips, rubber bands, Scotch tape, envelopes.
The vigilance over costs did not extend to executive remuneration and perks. Senior staff were earning between $25 million and $40 million annual in salary and bonuses. Bear Stearns’ chief executive was regularly the highest-paid executive on Wall Street. Million dollar Ferraris, executive jets, helicopters and expensive cigars were routine. In 2001 Bear Stearns spent €500 million on a seven-storey new headquarters, prompting one journalist to observe an investing rule-of-thumb of selling the shares of any financial institution building huge new headquarters.
Chief executive and board chairman Jimmy Cayne was a college drop-out. He preferred recruits with PS degrees – Poor and Smart – over MBAs. The firm had no qualms in recruiting people with tainted pasts. One trader, a professional gambler, when sacked by his previous employer for unauthorised trades and subsequently fined by the Securities and Exchange Commission (SEC), was sought after by Bear Stearns.
A common interest at the firm was bridge – thus the title of the book. Top partners played together, winning national and international tournaments. Jimmy Cayne was more often mentioned in bridge columns than on the business pages.
Another quirky aspect of the firm was the policy requiring partners to donate 4 per cent of their pay to charity. Bear Stearns became known as the biggest giver on Wall Street. Partners were not amused (unlike others) when the chief executive gifted €1 million to pay for Viagra prescriptions for men who could not afford them.
Apart from weaknesses arising from its unique culture, why did Bear Stearns fail?
An early event was converting the partnership to a public company in 1985. This shifted liability from the partners to the shareholders. Shareholders’ money was then used to take more risk. The focus went on increasing short-term profits and short-term bonuses at the expense of the long-term health of the firm and its shareholders.
SHORTLY AFTER GOINGpublic, the firm got into mortgage-backed securitisation. Having been a negligible force in this market in 1986, by 1988 it was the market leader.
A central policy of the Clinton administration was to increase home ownership among the poor. Pressure was put on what were seen as the conservative lending policies of the banks. This led to “financial ebola”, sub-prime credit toxic assets, the mad cow disease of structured finance where nobody knew who had consumed the infected product.
Bear Stearns’ borrowings were huge – 30 times or sometimes as high as 50 times assets. Its reliance on short-term overnight money doubled between 2007 and 2008. In the same period, Lehman Brothers reduced its exposure by 25 per cent. The overnight money relied on climbed to €75 billion daily.
In this exciting, action-packed and engaging read, the 10 days prior to takeover are described in minute-by-minute detail, facilitated by written records of BlackBerry-addicted executives, from e-mails, blogs and message boards, not to mention other media sources. These sources provide an accurate, real-time history. In this book, William Cohen has lifted the veil on the corporate world and provided his readers with a ringside seat to this fascinating corporate theatre.
Niamh Brennan is Michael MacCormac Professor of Management at University College Dublin, and is Academic Director of the Centre for Corporate Governance at UCD. She was recently appointed Chairman of the Dublin Docklands Development Authority and is also a non-executive director of Ulster Bank and the Health Service Executive (HSE)