By Brett Sherman, The Sherman Law Firm
In July 2007, Bear Stearns CEO Jimmy Cayne wrote to Bear Stearns hedge fund investors. Cayne's mission that day was critically important, and he knew it. In the wake of the shocking failure of two leveraged Bear Stearns hedge funds with heavy ties to the subprime mortgage market, the CEO needed to convey his confidence in the future of his company. Cayne cooly reassured hedge fund investors that Bear's conservative tradition, strong risk management culture, and plan to pare its mortgage backed securities portfolio would assure Bear Stearns a speedy and full recovery from the summer's disastrous fund collapses.
A year later, Cayne sang a completely different tune in an interview with Fortune. Fortune Magazine, "The Rise and Fall of Jimmy Cayne," August 2008. The ex-CEO of Bear Stearns revealed that the strength he projected in the summer of 2007 was in fact false strength.
According to Fortune,
Cayne "did not know how to deal with the devaluation of the firm's mortgage-backed securities and other illiquid assets. Nor did he know what to do ... when two hedge funds that contained those same toxic assets collapsed and further poisoned the company's balance sheet."
But wait, there's more!
Bear's all-powerful dictator admitted he was paralyzed by the crisis that his firm helped ignite in mid-2007. Cayne had absolutely no idea how to cope with the company's financial troubles.
"It was not knowing what to do. It's not being able to make a definitive decision one way or the other, because I just couldn't tell you what was going to happen."
Cayne even indicted himself regarding Bear Stearns' debt-laden balance sheet.
"I didn't stop it. I didn't reign in the leverage..."
said Jimmy Cayne. So there you have it. Cayne understood that Bear was super-leveraged and blamed himself for doing nothing about it.
While Cayne's numerous admissions to Fortune may sound like a deathbed confession, the former Bear Stearns CEO somehow still tries to convince us that Bear Stearns was done-in by a conspiracy of short-selling, rumor spreading hedge fund managers.
Perhaps the long-time CEO cannot face the fact that he was a primary contributor to the destruction of a company that, by all accounts, he loved to run. In any event, conspiracy theories about the end of Bear Stearns have been raised time and time again since March 2008. These theories have consistently wilted under even modest scrutiny.
Wall Street Law Blog has attacked many of Bear conspiracy theories in prior posts. Fortune discredits Cayne's delusions with simple common sense -
"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."
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." Id. Emphasis added.
Id. Emphasis added.
Breakingviews.com made this insightful comment about the Fortune Article:
"Cayne’s admission that he didn’t know what to do, even last summer, is extraordinary. If that was the case, [Cayne] should have handed the reins to someone else with more ideas – or been forced to do so by Bear's board. But no-one seems to have challenged his leadership until too late."
The consensus around the Wall Street Law Blog water cooler is that the Fortune article is remarkable.
Jimmy Cayne - still the all-powerful Oz at Bear Stearns for all of 2007 - admitted he was a deer in the headlights when he conducted damage control following the unprecedented collapse of Bear's subprime hedge funds. Clearly, Cayne misled the public by writing letters, issuing press releases, and participating in conference calls designed to sure up shaken confidence in Bear Stearns.
Cayne conceded he had no clue how to right the ship at Bear Stearns. Therefore, his false words of reassurance about Bear's future are fraud.
The CEO was not doing a thing to fix the numerous problems at Bear Stearns following the collapse of the subprime hedge funds (nor, apparently, was anyone else). Jimmy Cayne did not even bother to address the only real issue - how to restore Bear's health for the long-term. Cayne, in his own words, "didn't reign in the leverage." He could have.
Bear's 2007 fund disaster demonstrated in bright neon lights the extreme danger of over-reliance on leverage. By not taking affirmative steps to reduce leverage throughout the company, and by continuing to rely on short-term financing for the bulk of Bear Stearns operating costs, Cayne and the rest of Bear Stearns senior management (including soon to be CEO Alan Schwartz) were continuing a pattern characterized by a laser-sharp focus on short-term profitability, overconcentration of mortgage-backed-securities (MBS) in Bear's own portfolio, dangerous reliance on overnight repo financing to fund daily operating costs, a desperate need for a cash infusion, a total disregard for risk management, and a lack of concern for Bear Stearns shareholders or the long-term welfare of the Company.