The rise and fall of Jimmy Cayne (cont.)

In the end, Bear Stearns decided to lend around $1.6 billion to take out those lenders to the High Grade fund that had not already seized their collateral or had negotiated another arrangement with Cioffi. (The firm let the Enhanced fund fail.) But as the value of Bear's loan collateral - the prime and subprime mortgages in which the funds invested - continued to fall, the strategy quickly proved to be the wrong one, just as Cayne had feared. The firm lost around $1.2 billion of what it had just lent. The fallout was swift.

Cayne fired Spector on Aug. 5 - the final straw being Spector's decision to invest the $25 million in the hedge fund - and named Alan Schwartz the sole president and Sam Molinaro the chief operating officer the same day. (Schwartz, a well-regarded media M&A banker, had been at the firm since 1976; his status was such that his nickname was "Alan & Co.," a play on the media-focused investment bank Allen & Co. The affable Molinaro, at Bear since 1986, had worked his way up the ranks through the accounting and finance departments.) Personnel issues aside, the firm needed capital. Cayne's response was to embark on a series of clandestine trips. He flew to Beijing to persuade Citic, China's largest investment bank, to consummate a $1 billion stock swap. He also went to Orlando to meet for five hours with Joe Lewis -nicknamed "The Boxer." Cayne convinced Lewis - a Bahamas-based billionaire commodities investor and Bear Stearns brokerage client - that the firm's stock was a bargain and might be worth a big bet. The two bonded over a shared love of gin rummy. In September 2007, Lewis made the first of several purchases of Bear stock, spending $864 million for a 7% stake. (Lewis bought even more stock and lost around $1 billion when Bear collapsed. "He's an adult, not a whiner," says Cayne of the way Lewis reacted.)

By the time Cayne recovered from his sepsis and returned to the office at the end of September 2007, he and his firm were vulnerable. During the next several weeks Kohlberg Kravis & Roberts, Fortress Investment Group (FIG), and J.C. Flowers, among others, looked at Bear Stearns's books, but it reached no deal with any of them. On Oct. 22, the Citic deal was announced, but it was not a capital infusion and would take months to close. Then, on Nov. 1, The Wall Street Journal reported, citing unnamed sources, that Cayne smoked marijuana at "the end of the day" at bridge tournaments - including once in Memphis in 2004, when a woman smoked a joint in the bathroom with him - as well as in "more private settings." To the suggestion that he smoked pot, Cayne told the paper, "There is no chance that it happened. Zero chance." He followed that statement up with a further message of denial to all of Bear's 14,000 employees that he had not "engaged in inappropriate conduct." What's more, he told Fortune, "This story about smoking marijuana with some woman in a bathroom at a tournament site is pure fiction."

Cayne's denials made little difference. Bruce Sherman, still a major shareholder, began openly questioning Cayne's leadership with board members. At the end of November, the firm reported its first-ever quarterly loss - $854 million-after taking a write-down of $1.9 billion on its rapidly deteriorating holdings of mortgage-backed securities and other debt obligations. The write-down shaved 7% off Bear's $12 billion book value. By December the CEO was tired of being a "pinata," so he told his handpicked board he was thinking of retiring. "The options were limited," Cayne says. "When you become roadkill, when you happen to have lost some weight and you're not really healthy, but you know one thing - you know that you have worked your ass off and you're not smart enough to know the answer - that's tough."

It was not long before Schwartz told Cayne that a number of Spector's loyalists in the fixed-income and equity divisions were looking for his scalp. Cayne decided in January to retire rather than face further embarrassment. He continued coming into the office, trying to get the Citic deal closed. In February, he and Pat closed on the $27.4 million purchase of two adjacent apartments on the 14th floor of the recently renovated Plaza Hotel at the corner of Fifth Avenue and 59th Street.

As Bear Stearns's liquidity dried up in March, Cayne was playing bridge in Detroit, at the North American Bridge Championships. When playing tournaments, Cayne, who only recently got his first cell phone and has no BlackBerry, was hard to reach. While he saw Schwartz's March 12 appearance on CNBC - in which Schwartz said he was not aware of any imminent threat to Bear Stearns's liquidity - from his hotel room in Detroit, Cayne was not told of the firm's crisis until late Thursday night, March 13, when the "run on the bank" was already well along. Cayne was still playing bridge in Detroit when the board met by conference call that night, so he joined the call late. He didn't know about the Fed's rescue financing on Friday or that the stock had closed at around $30 that day after the credit agencies downgraded the firm. He couldn't get a private flight out of Detroit until four in the afternoon on Saturday (and no, he didn't think to call Northwest), so he arrived at Bear's office in New York at around 6:30 that night. "When I walked in they said, 'It's $8 to $12 a share. That's the deal with J.P. Morgan,'" remembers Cayne.

Given the situation, he wasn't surprised, but he understandably, gave some thought to what the deal would mean to him financially. "I'm saying, 'Six million shares,'" he remembers. "'I just got my butt kicked.'" On Sunday morning, before J.P. Morgan lowered the price to $4 per share and then quickly to $2 at the urging of Treasury Secretary Hank Paulson, Cayne went to the Jackson Hole restaurant at 91st Street and Madison Avenue for a couple of eggs with Vincent Tese, the billionaire chairman of Wireless Cable International and the lead independent director on Bear's board. The two had a frank discussion about the ramifications of what Cayne called playing the "nuclear card"threatening to file for bankruptcy. "But you can't play it," he said. "You can't play it. If anybody on earth would have played it, it would have been me."

On Sunday night he voted along with rest of the Bear board for the now infamous $2-a-share stock deal with J.P. Morgan rather than allow the firm to be liquidated beginning Monday morning. He also voted for the revised $10-a-share deal a week later, likewise to avoid another serious threat of liquidation. "I felt nothing," he says. "You got a bad grade on your test. That's it. No appeal. I felt sad for me and sad for my Bear Stearns family." To the bitter end, though retired, Cayne showed up in his office and in the executive dining room as if nothing had changed.

On March 25 - the day after J.P. Morgan revised its bid upward - Cayne and his wife dumped their 5.66 million Bear shares, at $10.84 each, for $61.3 million. (Arbitrageurs pushed Bear's stock to as high as $13.85 on March 24.) In a fit of pique, Greenberg charged Cayne $77,000 to execute the block trade when the employee discount would have merited a fee of just $2,500. "If he doesn't like it, he should do his future business elsewhere," Greenberg told the New York Times. (Cayne had previously sold some of his other Bear shares in February for roughly $80 each.) Now that the deal has closed, Cayne will also receive another $4.6 million in J.P. Morgan stock in exchange for his restricted stock units and for the shares in his capital-accumulation plan.

About the only unscripted moment in the final Bear Stearns shareholders meeting on May 29 came when Cayne commandeered the microphone on the dais in the company's auditorium. "When I retired [on Jan. 4], that was a sad moment," he told the crowd of roughly 400 people who were there to rubber-stamp the $10-per-share price. "This is equally sad. That which doesn't kill you makes you stronger. And at this point we all look like Hercules. Life goes on." With some anger he then launched into his view that nothing less than a "conspiracy" of unnamed financial sharks was responsible for the firm's downfall, and he hoped that the authorities would "nail the guys who did it."

By a "conspiracy" Cayne means that several hedge funds that stood to benefit financially from Bear's demise exploited the rumors about the firm's troubles to the point that customers and lenders decided not to do business with it. He looks forward to seeing if the Securities and Exchange Commission's investigation reveals any organized, concerted effort to bring down Bear Stearns, but he is skeptical. "That's not even a 100-to-1 shot," he says of the likelihood of the SEC's bringing charges. "That's a 500-to-1 shot." Still, he thinks a good place to start such an investigation would be with those firms that profited the most - to the tune of billions of dollars - from Bear's demise, including Goldman Sachs; hedge fund Paulson & Co., which cleared through Bear Stearns and whose principal, John Paulson, was a former Bear Stearns investment banker; and Kyle Bass, the head of Dallas-based Hayman Capital. (See Hayman's response.) In an interview, Gary Cohn, the co-president of Goldman Sachs, said it is "just preposterous and laughable" that his firm would be involved in a conspiracy with a select group of clients to bring down a fellow Wall Street bank. Neither Paulson & Co. nor Hayman Capital returned a call seeking comment.

What Cayne's conspiracy theory overlooks is the fragility of Bear's balance sheet. Regardless of whether hedge funds and short-sellers exploited the firm's weakness, it was Cayne and his colleagues who made the firm financially vulnerable. They sealed the firm's fate by choosing to finance the vast majority of the firm's daily needs - about $50 billion a day - in the overnight repurchase agreement (or "repo") market, using some 71% of its mortgage book as the collateral. (By contrast, Goldman Sachs finances less than 10% of its mortgage book in the overnight market, according to Cohn.)

Secured repos are crucial for investment banks, which borrow and lend billions to fund their daily business. Think of it this way: Wall Street firms have an inventory of hundreds of billions of dollars of securities that have been built up over the years (in the case of Bear, it was about $350 billion of assets). Like Macy's, the firms try to move this inventory as rapidly as possible, hoping to sell it for more than they paid. In the meantime, like Macy's, they use those assets as collateral to obtain financing to run their business. While Macy's uses its inventory and receivables to secure a revolving line of credit with a maturity of around four years, Bear and other Wall Street firms finance part of their inventories in the repo market. They sell their securities to investors at one price and agree to buy them back the next day for a slightly higher price. The difference is the investors' compensation for providing the financing. It is called "overnight repo" and for years it worked mostly without incident.

IfMacy's (M, Fortune 500) creditors had the ability to decide every night whether to finance its inventory, they could pull the plug on the company - especially if they felt Macy's had loaded the stockroom with questionable merchandise. Macy's would never do such a crazy thing, but this is exactly how Wall Street operates. Bear's reliance on overnight repo effectively gave the overnight lenders - such as Fidelity and Federated Investors - a vote on the firm's viability every night. And during that fateful week in mid-March, those overnight lenders voted a collective no. The result? Bear Stearns did not have enough cash on hand to meet customers' demands during the run on the bank.

After the final shareholders' meeting in May, Cayne spent his last hours at Bear Stearns chatting with a few loyalists who stopped by his lair to say their goodbyes. He took a call from Jamie Dimon, the CEO of J.P. Morgan Chase, who was checking in from Positano, Italy, to make sure the shareholder vote went off without a hitch. Finally it was time for him to leave his sixth-floor refuge at 383 Madison. But already things had changed. For years on Thursday afternoons, Cayne headed off early to the East 34th Street Heliport for the short $1,700 chopper ride down to the Hollywood Golf Club. But since his retirement in January, some luxuries had to be eschewed. So he put on his suit jacket, grabbed a freshly baked chocolate-chip cookie from his secretary's desk, and headed down to Vanderbilt Avenue. A car and driver were waiting to take him down the Garden State Parkway to Deal and his next round of golf. There would be no helicopter ride this day.

In "The Rise and Fall of Jimmy Cayne," Cayne asserts that there was a "conspiracy" responsible for Bear Stearns's downfall. He then suggests that a good place for the SEC to start an investigation would be "those firms that profited the most-to the tune of billions of dollars-from Bear's demise," including Kyle Bass, head of Dallas-based Hayman Advisors LP.

Cayne's inaccurate and sad comments only further illustrate the extent to which he was, and remains, deluded about his firm's demise. Hayman - which does not ordinarily disclose its holdings - did not have any positions in Bear Stearns' securities at the time of its failure and forced sale to JP Morgan. In short, Hayman did not stand to profit from the firm's failure. To the contrary, Bear Stearns was, and still is, one of Hayman's two prime brokerage relationships, and Hayman continues to maintain cash and security balances at the firm, now a part of JP Morgan.

Bass was a long-time Senior Managing Director of Bear Stearns and has many friends and former colleagues who have been seriously affected by the failure of Bear Stearns. He is saddened by the demise of Bear Stearns and the losses sustained by its employees. Bass finds it shameful that a Wall Street institution that took Ace Greenberg and thousands of hard working employees decades to build, could be destroyed so quickly by his successors.

While it is easy to dismiss Cayne's rant as a feeble attempt to deflect blame, if he truly believes that a "conspiracy" (rather than an ill-managed institution with a massively-leveraged balance sheet supported by toxic assets) caused Bear Stearns' demise, it leaves one trying to imagine the color of the sky in his world. Cayne probably summed up the situation best when he admitted that he was not "smart enough to know the answer."

Christopher E. Kirkpatrick, General Counsel, Hayman Advisors, LP 

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