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When the phones stop ringing, you\'re out of business


Date: Tuesday, March 18, 2008
Author: Jacquie McNish & Janet McFarland, Globe and Mail

Shortly before markets closed on Friday, traders at Bear Stearns Cos. Inc.'s New York headquarters did something that had never happened in the Wall Street firm's 85-year history: They left.

Hundreds drifted away from their trading desks on the 8th floor of the firm's Madison Avenue office tower and walked out of the building. Why? Because there was nothing for them to do.

Banks, hedge funds and investors on the other side of thousands of daily trades had lost faith in a storied Wall Street giant that made its name pinching pennies on even the office paper clips while placing astute market wagers.

By Friday, luck for the firm known as Bear had run dry. Some banks had stopped trading with the firm, others were demanding more collateral, big clients such as hedge funds were withdrawing cash from their accounts and credit rating agencies were downgrading its debt.

What Bear Stearns' senior managers, including legendary former chairman Ace Greenberg, witnessed when they visited the hushed floor on Friday was the modern equivalent of an old-fashioned run on the bank. Just as depositors lined up outside troubled banks during the Depression to yank their savings, Bear Stearns' trading clients fled because they no longer had confidence in Wall Street's fifth-largest investment bank.

As a result, a firm that had survived the Depression, the Second World War and numerous stock market collapses faced the humiliation of a government-assisted takeover by rival investment bank JPMorgan Chase & Co. that will likely vaporize most of the personal wealth of the firm's executives and cost the jobs of more than half of its 14,000 employees.

"It's a tragedy," said Christopher Whalen, a former Bear Stearns banker who is now managing director of consulting firm Institutional Risk Analytics. "There are thousands of people who are going to lose their jobs and their financial security because of this idiocy."

How did one of Wall Street's toughest firms, with a prized reputation for betting on the right side of risk, become synonymous with idiocy? The simple answer is that Bear Stearns placed a bigger bet than any competitors on the rapidly imploding world of subprime mortgage loans. The more complicated answer is that Bear is one of a number of major financial institutions that badly miscalculated the risks involved in so-called structured financial products linked to volatile assets such as subprime mortgages.

As delinquencies surge on subprime mortgages, investors and bankers have become increasingly reluctant to lend to players dangerously infected with the ailing loans.

What has stunned most market observers is that Bear Stearns has become the credit crunch's biggest casualty.

"It surprises people that they found themselves in this trouble, because the sharp traders usually know good credit risk from bad," said Charles Geisst, a Wall Street historian at Manhattan College.

Under Mr. Greenberg, the firm earned a reputation as a tough trading house that prized thrift and was cautious about risk. The son of an Oklahoma clothing retailer, Mr. Greenberg was so careful with money that he once issued an office memo forbidding the company from buying paper clips because "all of us receive documents every day with paper clips on them."

While other investment firms prized graduates from leading business schools, Mr. Greenberg preferred a breed of working-class recruits he called PSDs - Poor, Smart and a deep Desire to become Rich.

The strategy was so successful that by last year Bear Stearns stock sold for $170 (U.S.) a share on the New York Stock Exchange. Much of the rise was generated by enormous profits generated by its heavy investment in subprime mortgages. The firm was one of the first Wall Street players to concentrate on the high-yielding loans. At the time, the conventional mortgage business was dominated by major banks and federally sponsored institutions such as Fannie Mae. That left a riskier class of mortgages for new players such as Bear Stearns. By 2003 it had its tentacles in almost every aspect of the subprime business, lending money to borrowers, structuring specialized mortgage-linked investments and launching hedge funds that invested in subprime mortgages.

"They were the most exposed of all the investment banks," said Joseph Mason, a finance professor at Drexel University. When weakening U.S. housing prices and the onerous terms of subprime mortgages began to trigger foreclosures, the damage was swift to investments linked to the risky loans.

As the troubles began to mount, however, Bear Stearns damaged investor confidence by repeatedly understating its exposure to the crisis. When Bear Stearns announced a $3.2-billion bailout last June for a fund linked to subprime loans it described its troubles as "fairly contained."

Six weeks later, the firm sought bankruptcy protection for the fund and another damaged by housing woes. Five days after the bankruptcy filing, Bear Stearns told clients in a letter they could "rest assured" that the firm would serve them well. A month later, it reported a 68-per-cent drop in quarterly profit.

When market rumours began to swirl March 10 that Bear Stearns did not have enough cash to stay in business, the firm said: "There is absolutely no truth to the rumours of liquidity problems that circulated today in the market."

Four days later, the trading desks ground to a halt and the U.S. Federal Reserve threw it an emergency funding lifeline as it scrambled to negotiate a fire sale with JPMorgan.

"Bear Stearns has been one of the most egregious over the past year in claiming ... there's no real credit crisis and their portfolio is sound and there's no need to worry," Prof. Mason said. "They've been saying that while things got worse and worse."

One person who shared Bear Stearns optimism was reclusive British billionaire Joe Lewis. Last summer he paid $100 a share for a nearly 10-per-cent stake in the firm. Yesterday he described JPMorgan's $2-a-share offer for Bear Stearns on CNBC as "derisory." He said he does not expect JPMorgan to be successful in closing the deal.

Other major Bear Stearns investors include Putnam Investment Management LLC, a fund manager owned by Great-West Lifeco.

Crisis of confidence

June 22, 2007 Bear Stearns says its troubles are 'relatively contained' after it commits $3.2-billion (U.S.) in secured loans to rescue one of its hedge funds hit by subprime mortgage losses.

Aug. 1 Two Bear hedge funds file for bankruptcy protection.

Aug. 6 Bear sends letter to clients reassuring them the firm is financially healthy. 'Rest assured, Bear Stearns has seen challenging markets before and has the experience and expertise to serve you and us well.'

Sept. 20 Bear reports 68-per-cent plunge in quarterly profit.

Nov. 14 Bear announces $1.62-billion writedown.

Jan. 7, 2008 Bear CEO James Cayne retires.

March 10 In response to market rumours, the firm says: 'There is absolutely no truth to the rumours of liquidity problems that circulated in the market.'

March 14 Federal government and JPMorgan Chase provide emergency funding to Bear.

March 16 JPMorgan announces deal to acquire Bear Stearns.

Associated Press