Inside the Bear Stearns boiler room

Exclusive book excerpt: Bestselling author William Cohan uncovers the inner workings of the misadventure that brought down Bear Stearns and foreshadowed the financial crisis to come.

EMAIL  |   PRINT  |   SHARE  |   RSS
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all RSS FEEDS (close)
By William D. Cohan

NEW YORK (Fortune) -- Years from now, when academics search for causes of the stock market crash of 2008, they will focus on the pivotal role of mortgage-backed securities. These exotic financial instruments allowed a downturn in U.S. home prices to morph into a contagion that brought down Bear Stearns a year ago this month - and more recently have brought the global banking system to its knees.

What scholars should not miss is the role that the human element - call it greed or ignorance - played in this tragedy. In an exclusive excerpt from William Cohan's new book, "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street," to be published March 10 by Doubleday, the bestselling author sheds light on the bankers who thought they had mastered what Warren Buffett has called "financial weapons of mass destruction."

By looking back to the roots of the misadventure in which Bear Stearns traders Ralph Cioffi and Matthew Tannin lost roughly $1.6 billion while allegedly misleading investors, Cohan illustrates how the missteps of the few can have consequences for the many.

When the first jet hit the World Trade Center towers on the morning of September 11, 2001, Jimmy Cayne, then chairman and CEO of Bear Stearns, turned on a small television in his midtown Manhattan office and watched in disbelief as the second jet hit the south tower. Later in the day, Cayne got a call from Richard Grasso, then CEO of the New York Stock Exchange, telling him that it was important to the United States government that the exchange reopen as quickly as possible. To that end, Grasso said there would be a meeting the next morning at the stock exchange among the heads of all the Wall Street firms.

When Cayne woke up the next morning, he saw on the news that New York City had closed off access to lower Manhattan below 15th Street, including the New York Stock Exchange. Cayne called Grasso at home and offered to host the meeting instead at Bear Stearns. Grasso quickly agreed to Cayne's suggestion, and the meeting was held in the seventh-floor boardroom on Wednesday at two o'clock. "Everybody in the world was there," Cayne said. "Everybody. This was heavy cake. I've never seen all these people, the heads of every major firm, sit in a room and not hate each other."

Bear Stearns, the fifth-largest U.S. investment bank, survived the 9/11 attacks unscathed, just as it had survived unscathed every other major crisis since its founding in 1923, among them: the Great Depression, World War II and the 1987 market crash. Indeed, until the very end, the firm had never had a losing quarter in its history. But in the months following 9-11, Cayne and his senior management team, including Alan "Ace" Greenberg, Warren Spector and Alan Schwartz would unwittingly sow the seeds of the firm's destruction by betting heavily on the manufacture and the sale of mortgage-backed securities.

In the short run, the decision by Bear's executives to become a leader in this business resulted in huge profits for the firm - and massive paychecks for them. Along with bankers at Lehman Brothers, Merrill Lynch and Morgan Stanley (MS, Fortune 500), they were only too happy to capitalize on the mortgage boom that occurred in the wake of 9-11 when the Federal Reserve loosened the money supply.

One of Bear Stearns profit centers was a small hedge-fund division. The firm seeded it with a relatively trifling $45 million equity investment. Ralph Cioffi (pronounced Chee-off-ee), a longtime Bear Stearns fixed-income salesman turned hedge-fund manager, ran it. The funds were part of the firm's relatively tiny asset management business, known as BSAM. BSAM reported to Warren Spector, Bear's resident wunderkind, who as the firm's co-president (with Alan Schwartz) was responsible for overseeing 90% of its revenue, including its massive fixed-income business.

Like Cayne and Ace Greenberg, the boyish Spector was a world-class bridge player and many people both inside and outside Bear Stearns considered it inevitable that he would one day soon run the firm. In October 2003, Spector's friend Cioffi moved from Bear's fixed-income department to BSAM, and set up a hedge fund, called the High-Grade Structured Credit Fund, with money from outside investors. The fund eventually would have around $1.5 billion of investors' cash in it. Then 47, Cioffi had joined Bear Stearns in 1985 as an institutional fixed-income salesman, specializing in structured finance products.

Cioffi grew up in South Burlington, Vermont, near Lake Champlain. From 1989 to 1991, he was the New York head of fixed-income sales and then, for the next three years, served as global product and sales manager for high-grade credit products. As a salesman, Cioffi covered the Ohio Public Employees Retirement System account and was making around $4 million, year after year. "He was the top fixed-income salesman in a firm where fixed income was king," said one senior managing director.

"We all grew up with Ralph here," explained Paul Friedman, who was the chief operating officer of Bear's fixed-income division. "Ralph is one of the smartest guys I've ever met and was absolutely the best salesman I've ever met. When I was a trader, he was a salesman, a fabulous salesman. He was incredibly personable, incredibly smart, creative and could get things done." As a manager, Cioffi was another story. "He had adult ADD," says Friedman.

Helping Cioffi run the hedge fund was Matthew Tannin, six years his junior. Tannin, born in New Jersey, was a graduate of the University of San Francisco law school. He joined Bear Stearns in 1994 and spent seven years structuring collateralized debt obligations. In 2001, he moved over to research, where he studied the trading and value of CDOs.

At the outset, Cioffi and Tannin (pronounced Ta-neen) told investors the High-Grade Structured Credit Fund would invest in low-risk, high-grade debt securities, such as tranches of CDOs, which the ratings agencies had rated either AAA or AA. The fund would focus on using leverage to generate returns by borrowing money in the low-cost, short-term repo markets to buy higher yielding, long-term CDOs.

The difference between the interest rate at which the fund could borrow money and the yield on the CDOs, enhanced by the use of borrowed money, would generage the fund's profits. In August 2006, Cioffi and Tannin decided to open a second fund, the Enhanced Fund, that used substantially more leverage - and took more risk - than the High-Grade Fund. The Enhanced Fund had about $600 million of investors' money in it and used a $400 million credit facility from Barclays, the large British bank, to leverage the securities Cioffi and Tannin bought.

For 40 months, Cioffi's High-Grade hedge fund never had a losing month. During that time, it achieved a 50% cumulative return. The Enhanced Fund also performed well during its short existence. In typical hedge fund fashion, BSAM kept 20% of the profits generated by the funds plus a 2% fee on the net assets under management; fees from the High-Grade Fund alone accounted for 75% of BSAM's total revenues in 2004 and 2005.

Trading securities and Ferraris

Cioffi lived very well. In 2000, he and his wife, Phyllis, purchased a home for $815,000 in Tenafly, New Jersey, that in 2007 was assessed for $2.6 million. He owned a home in Naples, Florida, valued at $933,000, and a home in Ludlow, Vermont, valued at $2.2 million. He owned an apartment at the Stanhope, on Fifth Avenue in Manhattan, and a $10.7 million, 6,500-square-foot home in Southampton, Long Island, which had six bedrooms, seven baths, a pool, a tennis court, and a separate guesthouse on two and a half acres.

He was the executive producer of the 2006 independent film "Just Like My Son," starring Rosie Perez. But Cioffi's real passion was for Ferraris. At one point, he owned two of them: a $250,000 F430 convertible Spider and a $300,000 front-engine V-12 Superamerica. One day, his Ferrari dealer in Spring Valley, New York - in Rockland County - called him up and told him he had one low-mileage Ferrari Enzo for sale. Was Cioffi interested in a trade of his two Ferraris plus some cash for the Enzo? Only 399 of the Enzos were built from 2002 to 2004, and they originally cost $650,000 each. Nowadays, if you can find one, it will cost around $1.2 million. After getting the call from the dealer, Cioffi called up Doug Sharon, a longtime Bear broker and car aficionado who ran the firm's Boston office.

"Do you think I should do the trade?" Cioffi asked Sharon. "The dealer wants me to do this trade."

"Ralph, as far as I'm concerned, it's a no-brainer," Sharon told him. "You gotta do it. Your two cars and some cash for an Enzo? Enzos are hard to find."

"It's not exactly the kind of car I'm gonna drive down to the golf club with," Cioffi responded. For Sharon, the conversation with Cioffi about the Enzo "was probably the beginning of the end, when Ralph's thinking about buying million-dollar Ferraris."

Cioffi pulls his money out

By the time Bear Stearns released its 2006 annual report in mid February 2007, Cioffi had more on his mind than trading Ferraris. Bear Stearns had a banner 2006: $9.2 billion in revenue, and it had made $2.05 billion of net income, the first time that milestone had been reached. Profit had increased 40% from 2005. Standard & Poor's upgraded Bear Stearns to A+ with a stable outlook. Unbeknownst to shareholders, though, problems in the housing market were starting to effect Cioffi's funds' performance.

February 2007 had been a very difficult month for Cioffi's two hedge funds. The High-Grade Fund had reported a gross return of 1.5% - respectable, to be sure - but the Enhanced Leverage Fund had lost 0.08%, the first time either fund had lost money since Cioffi started in 2003. But that was not the message that Tannin sent to Barclays about the February performance of the Enhanced Leverage Fund. "You will be happy to know that we are having our best month ever this February," he e-mailed the bank on February 19.

On March 1, Cioffi told an economist who worked for the hedge funds, "Don't talk about [the funds' February results] to anyone or I'll shoot you." He also went on to say that he thought the funds might have their first down month ever and that he was disappointed by that fact. The next day, Cioffi met informally with Tannin and two other members of the funds' management team and spoke "about the extremely difficult month" February had been for the funds, though he claimed that the funds "had averted disaster." With his team around him, Cioffi "led a vodka toast to celebrate surviving the month," according to the June 2008, federal grand jury indictment of both Cioffi and Tannin. Both Cioffi and Tannin declined to comment for this account.

Cioffi was becoming increasingly concerned about the funds' exposure to the subprime market, even though the monthly statements sent to investors stated that only 6% of the funds' money was invested in subprime. Cioffi was concerned because he knew that actually the funds had closer to 60% of their money invested in subprime mortgages.

March was not going to be a good month, either. On March 15, Cioffi wrote a colleague by e-mail, "I'm fearful of these markets. Matt [Tannin] said it's either a meltdown or the greatest buying opportunity ever. I'm leaning more towards the former."

On the very same day, Tannin portrayed the funds in a different light, telling an investor, "We are seeing opportunities now and are excited about what is possible. I am adding capital to the Fund. If you guys are in a position to do the same I think this is a good opportunity," and he added that "it was a very bad time to redeem." Tannin never did invest more of his own money in the funds.

Finally on March 23, Cioffi initiated the process of removing $2 million of the $6 million that he personally had invested in the Enhanced Leverage Fund. He moved the money to another Bear hedge fund, Structured Risk Partners, of which Cioffi had oversight responsibility beginning April 1, and which had still been performing well. For appearance purposes, hedge fund managers were expected to invest in the hedge funds they managed, and Cioffi's defenders suggest that this alone was the reason he moved the cash. The High-Grade Fund lost 3.71% for the month. The Enhanced Leverage Fund lost 5.41%.

'The subprime market is toast'

After 40 months of positive returns, the sudden and sharp decline in the two hedge funds was new territory for Cioffi and Tannin. They struggled mightily to figure out what to do. On April 18, one of Cioffi's investors, who had $57 million invested, informed him that he was considering redeeming his money. Cioffi told the investor that the portfolio managers had $8 million of their own money invested, one-third of their liquid net worth. He neglected to tell the investor that he had taken $2 million of his own money out and invested it in his other hedge fund.

On April 22, Tannin wrote Cioffi an e-mail from his personal Gmail account to Cioffi's wife's personal Hotmail account with the subject line "Things to Think about - Parts I and II."

He wrote at times with great emotion and about his personal feelings, which may have accounted for his decision not to write the e-mail on the Bear Stearns system. Tannin, a philosophy major, was certainly waxing philosophical in the correspondence. "We have spent our time well - and time is the ONLY thing in this life which one can't ever get back." He said he was feeling "pretty damn good" about what was happening at the funds because he had no doubt "I've done the best possible job that I could have done. Mistakes, yep, I've made them - but they do not bother me as much as they did years ago.... So - f*** it - all one can do is their best - and I have done this."

He went on to wonder whether the funds should be closed or significantly restructured. The argument for closing the funds was based on the market and on a complex internal April 19, CDO report, which was a new analysis that Tannin had recently perused. "If we believe the [new CDO report] is ANYWHERE CLOSE to accurate, I think we should close the funds now. The reason for this is that if [the CDO report] is correct, then the entire subprime market is toast," wrote Tannin. "If AAA bonds are systematically downgraded, then there is simply no way for us to make money - ever."

On April 25, Cioffi and Tannin held a conference call for the funds' investors, who were getting skittish. Cioffi and Tannin's performance was Oscar-worthy. Cioffi kicked the discussion off with a review of the first-quarter performance at both funds. The High-Grade Fund was down a cumulative 0.34% in the first quarter, with the loss coming in March after a positive January and February; the Enhanced Leverage Fund had lost 4.74% year to date, with much of the loss coming in March. "At this point in time, the [Enhanced] fund has significant amounts of liquidity," Cioffi said. He then predicted returns of 14% for the year in the Enhanced Leverage Fund and 11% for the year in the High-Grade Fund.

A charitable view of Cioffi's predictions for the funds' 2008 performance would be that he was badly mistaken; another view would be that he deliberately misled investors to keep them from seeking a stampede of redemptions, which would spell the end of the funds and of Cioffi's lavish lifestyle.

Bear puts more skin in the game

Two factors that Cioffi and Tannin could not have foreseen were starting to cripple their funds. Investors spooked by the January and February returns put in redemption orders for well over $100 million. With less new money flooding into Cioffi's funds and BSAM being forced to sell assets out of the funds, the small esoteric market became less liquid. The second factor was the creation in January 2007 of an index - known as the ABX index - that for the first time allowed investors to bet on the performance of the subprime mortgage market in much the way an S&P index fund allows them to bet on the direction of the stock market as a whole. The ABX was an index of securities backed by home loans issued to borrowers with weak credit.

"In previous times, if the market sold off, no one really knew how much," Friedman explained. "Now you had a published index that people could observe. More importantly, it was the only real thing they could short as a hedge. As a result, the index got driven lower and lower as people looked for a way to hedge, going far lower than the underlying bonds. Potential buyers then demanded to buy bonds at the levels that the index suggested they should trade [at] when in fact no one was willing to sell there. So you had a period of time when, for example, the index would trade at 90 but the underlying bonds traded - when they traded - at 95. Hence, there would be no trades."

On May 1, despite mounting redemption notices, Bear's co-president Warren Spector invested an additional $25 million into the fund, bringing the firm's total stake to more than $500 million in hedge funds and other seed capital opportunities. Spector made the additional investment without taking a thorough look at the analytics and without consulting with his boss Jimmy Cayne - a decision he would come to regret even though it was within his authority to do so.

Goldman questions Bear's marks

Despite what they said in the April 25 conference call, by early May both Cioffi and Tannin anticipated that the funds' April results were going to be rough. Cioffi published the net asset value (NAV) for the Enhanced Leverage Fund for April at -6.5%. A week later, Goldman Sachs sent, by e-mail, its April marks on the securities to Cioffi. As a counterparty to trades in the funds, Goldman was obligated to report its thinking about the value of the securities in the funds on a monthly basis.

"Now there's a funny little procedure that the SEC imposes on you, which is that even if you get a late mark, you have to consider it," explains one former Bear executive. "They give us these 50 and 60 [cents on the dollar] prices. What we got from the other counterparties is 98. The SEC rules say that when you do this, you either have to average them - but they're meant to be averaging 97s and 98s, not 50s and 98s.... So we have to repost our NAV. And now we go from minus 6 [percent] to minus 19 [percent] - minus 18.97 [percent] to be exact - and that is game f***ing over. By the way, the firm that sent us the 50 made a s**t-pot full of money in 2007 shorting the f***ing market."

Gary Cohn, the co-president of Goldman Sachs (GS, Fortune 500), had a few reactions to the charges made by the Bear executive. First, he was clear that Goldman did not make nearly as much money in 2007 betting against the mortgage market as people think it did. "We don't disclose segment-by-segment reporting," he said. "But the market would be really disappointed if they saw our actual mortgage results last year, because they think we made a lot of money." As for the marks themselves, Cohn said that Goldman was aggressive about marking down these kinds of securities, especially during the third quarter of 2007, much to the detriment of its own income statement and those of some of their clients who would then have to account for the new Goldman marks.

He then shared an anecdote about a conversation he'd had with Nino Fanlo, one of the founding partners of KKR Financial Holdings, a specialty finance company started by KKR, the private equity shop. After Goldman sent out the marks in the 50 to 55 range, Fanlo called Cohn and told him, "You're way off market. Everyone else is at 80, 85." Cohn then offered to sell Fanlo $10 billion of the paper at his 55 price and encouraged him to sell that in the market to all the other broker-dealers at the higher prices they claimed to be marking the paper at. In other words, Cohn was offering Fanlo a windfall: buy at 55 and sell at 80. "You can sell them to every one of those dealers," Cohn told Fanlo. "Sell 80, sell 77, sell 76, sell 75. Sell them all the way down to 60. And I'll sell them to you at my mark, at 55, because I was trying to get out. So if you can do that, you can make yourself $5 billion right now."

Cohn had been trying to sell the securities at 55 for a period of time and people would just hang up on him. A few days later, Fanlo called Cohn back. "He came back and said, 'I think your mark might be right,'" Cohn said. "And that mark went down to 30."

Cohn said the market changed dramatically through the course of the year. "We marked our books where we thought we could transact because some of this stuff wasn't transacting," says Cohn. "We sold stuff at 98 and marked it at 55 a month later. People didn't like that. Our clients didn't like that. They were pissed."

The moment the bid-ask spread on these securities widened to the point where there needed to be such a fulsome debate about their value was the beginning of the end.

Shouting fire in a crowded theater

As the BSAM funds collapsed, Bear Stearns co-president Warren Spector suspected Cioffi and Tannin might need help. On June 5, Spector walked into Paul Friedman's office, and Friedman remembers Spector saying, "I think Ralph's got a liquidity problem. Could you see if you could help?' Talk about your great understatement of all time." On June 7, Cioffi announced that redemptions from the Enhanced Fund would no longer be permitted, regardless of whether a redemption notice had already been submitted.

"I go over to see Ralph with the BSAM guys, and not surprisingly, the announcement that he was suspending redemptions had caused his fourteen lenders to raise their margin requirements, mark down the collateral, and start to squeeze," Friedman said. (By this time, BSAM had moved out of Bear's headquarters at 383 Madison Avenue into a separate office down 46th Street, at 237 Park Avenue.) "And so I sat with Ralph and I said, 'Take me through it. You must be OK. You've got all your funding locked up, non-recourse, no margin calls for term, right?' He goes, 'Yeah, most of it,' and so we go through the balance sheet, and he's got about $14 billion of mostly high-quality stuff, but not entirely, and his average funding is about a month, and I said to him, 'How long would it take you to sell that?' He goes, 'Well, I could probably sell a third in six months.' I said, 'What are you gonna do if you get a margin call?' He goes, 'Well, I've got some more of the same stuff fully paid for in the box.' I said, 'How much?' He goes, 'A few hundred million.' I went, 'You're dead.'"

On the advice of the restructuring team at the Blackstone Group, the BSAM team decided to call a June 14 meeting of the repo lenders to Cioffi's hedge funds. The basic gist of Bear's strategy was to ask these creditors to be patient so that an orderly liquidation in a less pressured environment could commence. Blackstone's theory of the situation was that the very same banks that were repo lenders to the funds were up to their eyeballs in the very same illiquid mortgage securities that Cioffi had. Therefore, no one would have any incentive to force a sale of the securities into a frozen market and thus establish a new, lower mark that everyone would have to adopt.

"It was the classic Mexican standoff, where nobody wins if everybody's dead on the floor at the end of this thing," explained one person involved with the strategy. "Our point was, 'All you guys have this problem. It doesn't help any of you to flood the market with this paper'...But it was like any other panic. If you're out early enough, maybe it is good for you."

The repo counterparties' meeting took place in the second-floor auditorium at Bear Stearns headquarters at 383 Madison Avenue. The tactic backfired completely. Two days later, Merrill Lynch ignored Cioffi's request for a thirty-day standstill and seized $400 million of its collateral from the funds with the intention of auctioning the assets in the market at noon on Monday. Says Friedman, "had he not been the first fund to go, it would have had a much lower impact as well.... But it was like the pebble being tossed into the pond. It was pulling on the thread. It was any analogy you want to use."

'Bag the funds'

Around the middle of June 2007, Chairman and CEO Jimmy Cayne decided to convene a meeting of the twenty most senior executives at the firm to get an update of what was going on with Cioffi's hedge funds and to decide whether or not the firm should agree to become the repo lender to the funds. To that point, Bear Stearns' only exposure to Cioffi's hedge funds was its $45 million equity investment, and the rest of Wall Street was waiting for Bear Stearns to put together a rescue plan.

Before going into the meeting, Cayne asked Steve Begleiter, the firm's head of strategy, how much money Bear had invested in the funds. Cayne told Begleiter he thought the amount was $20 million; Begleiter corrected him and informed him the firm actually had $45 million invested. Cayne remembers saying, "Where did the other 25 come from?' So Begleiter said, 'I don't know.' I said, 'You don't know where the 25 comes from?' He said, 'No.' We walk in, I said, 'Before we discuss what we're going to do, does anybody know about $25 million that was put into the funds at the last minute?' Spector said, 'I did. Sorry.' No, he didn't say 'I'm sorry.' He said, 'I f***ed up.' If he had said 'I'm sorry,' it would have been different. He said, 'I f***ed up.' Now there's silence. People were expecting me to say, 'What are you, f***ing crazy? Unauthorized, you yourself authorized $25 million into a failing enterprise.' Well, I didn't, but I also didn't say anything for like a minute. I just let everybody hear him say, 'I f***ed up.'"

After shining the bright light of blame on Spector's decision to invest the extra $25 million into the funds on his own authority, Cayne asked the group what to do about the funds. 'I said, 'Okay, so what are our options? It seems to me the first option is we just bag the funds. We suffer a reputational risk, which we aren't really going to avoid anyway. And we save ourselves the heartache of that crap coming into us.' Nobody said anything."

By June 22, Spector was on the phone with other Wall Street executives. His message to them was that Bear Stearns had finally decided to step up in a significant way to help the hedge funds (Cayne's pitch to let them fail had not carried the day with his fellow board members). But the level of the rescue was not quite what the Street had expected. Spector outlined a plan in which Bear would become the new repo lender - up to a total of $3.2 billion - to the High-Grade Fund only and would do nothing for the Enhanced Leverage Fund, effectively signaling that the second fund would fail and be liquidated. (In the end, Bear Stearns lent around $1.5 billion to the High-Grade Fund.)

Now the hard work of figuring out what the firm had just agreed to buy had to begin. "It took two or three weeks to mark," explained Friedman. "It literally took a dozen people on the mortgage desk night and day, and a bunch of our research people night and day and weekends, three weeks to value this stuff, which tells you just how illiquid it was."

By the time they did figure out what most of it was worth, the firm had miscalculated badly. "We thought there was $400 million-ish of cushion, and in fact, as it turned out, we missed by like $1 billion out of $1.5 billion," says Friedman. "It was not even close. You would think you could get it to the nearest billion, and a lot of it was the market deteriorating dramatically in that five or six weeks. But it was just a guess to begin with."

On July 17, Cayne announced the seemingly inevitable news that the hedge funds were kaput. On July 30, the hedge funds' boards of directors authorized the funds to file petitions for liquidation under the Cayman Islands' Companies Law under the supervision of the Cayman Grand Court. Subsequently, both a U.S. bankruptcy court and a U.S. district court of appeals struck down the legitimacy of the Cayman Islands venue for the filing. As a consequence of the filing, Bear Stearns seized $1.3 billion of underlying collateral - Cioffi's panoply of illiquid mortgage-backed securities - that it had been financing for all of one month and absorbed it onto the firm's balance sheet. Not long after, Cioffi and Tannin were fired.

Where are they now?

The hedge-fund debacle and the fateful decision to lend $1.5 billion to the High-Grade Fund led to Bear Stearns' first quarterly loss in its 85-year history, in the three months ended November 2007. Besides Cioffi and Tannin, there was other collateral damage. On August 1, 2007 Jimmy Cayne fired Warren Spector. On January 2008, Cayne resigned as CEO probably within days of a coup d'etat that was percolating throughout the firm's corridors. (Cayne remained the Chairman of the firm's board of directors).

With both Cayne and Spector dispatched, Bear Stearns had little choice but to turn to Alan Schwartz, the firm's most prominent investment banker, and ask him to be the CEO, the first time an investment banker had run the firm, which had always been predominantly a fixed-income shop. As respected as Schwartz was on Wall Street, he had little knowledge of the world of trading and fixed income, let alone the billions of dollars of complex, mortgage-related securities that were larding the firm's balance sheet. He decided not to raise additional equity capital for the firm or to seek a merger partner. He determined Bear Stearns could continue to go it alone and succeed.

That was yet another fateful decision. Within two months of his appointment as CEO, investors, repo lenders, hedge-fund clients and trading counterparties all began to question the firm's efficacy - the endgame that began nine months earlier with the disaster in Cioffi's hedge funds. The failure of Bear Stearns during the four days beginning March 12, 2008, culminating in its sale for a pittance to JPMorgan Chase (JPM, Fortune 500) on March 16, meant that no firm on Wall Street could any longer be considered safe, especially those firms such as Lehman Brothers, Merrill Lynch and Citigroup (C, Fortune 500) that had even more mortgage-related securities on their balance sheet than did Bear Stearns. The historic unwind of 2008 had begun.

As has become all too apparent, the problems that overwhelmed Bear Stearns were not unique to that firm - far from it. Nearly every large firm on Wall Street with a significant capital markets business - Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley to name several - have been damaged by the still-unfolding crisis. Still to be determined is the fate of both Citigroup and Bank of America (BAC, Fortune 500) as independent companies.

As for Cioffi and Tannin, the traders who started the panic, they were indicted in June of 2008 by U.S. Attorney Benton J. Campbell, of the Eastern District of New York, on charges of conspiracy, securities fraud and wire fraud in conjunction with their management of the two Bear Stearns hedge funds from their inception in 2003 to their bankruptcy filing in July 2007.

Cioffi was also indicted on charges of insider trading related to his decision to move $2 million of his own money out of the Enhanced Leverage Fund - without telling investors - into another hedge fund he managed that had, to that point, superior returns.

The indictment also revealed that both Cioffi's notebook and Tannin's tablet computer had disappeared after federal authorities had asked for them to be produced. The indictment alleged that by March 2007, both Cioffi and Tannin "believed that the [f]unds were in grave condition and at risk of collapse. However, rather than alerting the Funds' investors and creditors to the bleak prospects of the [funds] and facilitating an orderly wind-down, the defendants made misrepresentations to stave off withdrawal of investor funds and increased margin calls from creditors in the ultimately futile hope that the [f]unds' prospects would improve and that the defendants' incomes and reputations would remain intact."

On the same day as Cioffi and Tannin were indicted in the Eastern District, the SEC filed civil charges against both men. If convicted of securities fraud, they face maximum sentences of 20 years of imprisonment. If convicted of conspiracy, they each face a maximum sentence of five years. (At press time, there were no further public proceedings in this matter.)

The former senior management of Bear Stearns is faring better than Cioffi and Tannin. Longtime CEO Jimmy Cayne has retired and is spending the month of March in Australia playing bridge. Short-lived CEO Alan Schwartz has had many offers to return to Wall Street at both large and small firms but has opted to continue to work by himself out of a few modest offices provided by Rothschild, the international investment bank, on Sixth Avenue in New York. (He serves as an advisor to Jeff Bewkes, the CEO of Time Warner, Fortune's parent company.)

Warren Spector has fielded offers to return to Wall Street, too, but so far has preferred to spend his time as chairman of the board of trustees of The Public Theatre, on Lafayette Street, and on overseeing the renovation of the Greenwich Village townhouse he bought for $33 million in November 2006. Alone among the former top Bear Stearns' executives, Ace Greenberg, now 80 years old, sought and received a sinecure from JPMorgan Chase as part of the acquisition. He works as a broker, managing his own and his few clients' money.

So should these men share in any blame for what happened to the capital markets in the wake of Bear Stearns' collapse? Former Bear CEO Alan Schwartz has told friends that he sees their role this way, "These things happen and they're big, and when they happen everybody tries to look at what happened in the previous six months to find someone or something to blame it on. But, in truth, it was a team effort. We all f***ed up. Government. Rating agencies. Wall Street. Commercial banks. Regulators. Investors. Everybody."

Excerpted from House of Cards: A Tale of Hubris and Wretched Excess on Wall Street by William D. Cohan, to be published in March, 2009 by Doubleday Books, a division of Random House, Inc. Copyright 2009 by William D. Cohan. To top of page

Company Price Change % Change
Ford Motor Co 8.29 0.05 0.61%
Advanced Micro Devic... 54.59 0.70 1.30%
Cisco Systems Inc 47.49 -2.44 -4.89%
General Electric Co 13.00 -0.16 -1.22%
Kraft Heinz Co 27.84 -2.20 -7.32%
Data as of 2:44pm ET
Index Last Change % Change
Dow 32,627.97 -234.33 -0.71%
Nasdaq 13,215.24 99.07 0.76%
S&P 500 3,913.10 -2.36 -0.06%
Treasuries 1.73 0.00 0.12%
Data as of 6:29am ET
More Galleries
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.