GUEST COMMENT: Risking shareholders' money for the benefit of employees is so over
The one-year anniversary of the collapse of the global investment bank Bear Stearns, last March, has occasioned many observers to look back and wonder whether there was a certain inevitability to it all.
The truth, as I describe in detail in my new book, House of Cards, is that the way Bear had chosen to finance itself at the end - by borrowing as much as $75bn a day in the overnight 'repo' markets - made the firm extremely vulnerable to any sudden loss of confidence.
Nearly every Wall Street firm did some financing in the overnight repo market because the interest cost for the money was dirt-cheap and helped boost the overall profitability of the firm. But Bear tapped the repo market to a greater degree than any other Wall Street investment bank, and had done so successfully for years.
Since Bear's five-member executive committee was paid based on the firm's Return on Equity (they split some $150m among themselves in 2007), there was always a large incentive for its members, such as CEO Jimmy Cayne and former CEO Ace Greenberg, to seek to increase profits at all costs.
The problem with relying on overnight financing to keep the firm well-oiled was that it gave the firm's numerous creditors a vote every night on whether to keep doing business with it.
It didn't help that as collateral for these overnight loans, which came from the likes of Federated Investors and Fidelity Investments, Bear used its growing stockpile of mortgage-backed securities.
During the firm's final week last March, in the wake of troubles at UBS -- in its Alt-A mortgage portfolio -- at Peloton Partners, a hedge fund that liquidated in February due to large investments in mortgage securities, and at Carlyle Capital Corporation, an affiliate of the Carlyle Group, that ran into the same trouble as Peloton, questions began to circulate in the market about the valuation of Bear's huge portfolio of mortgage-backed securities, which were used as collateral for the overnight financing.
As the value of the collateral continued to fall, the overnight lenders began to demand more collateral or simply decided that the risks of doing business with Bear Stearns outweighed the rewards. As the fateful week rolled on, fewer and fewer of the overnight lenders agreed to provide financing to Bear Stearns until Thursday night, when virtually all of the lenders said, "Nada Mas!"
Bear had no choice but to file for bankruptcy or seek a government bailout. The rest is history.
Those on Wall Street - including a number at Bear Stearns - that understood the financing game Bear was playing, recognize readily that Bear executives bear sole responsibility for what happened to the firm and why.
Of course, that does not in any way mean that Bear - where some 14,000 extremely talented and hard-working employees made their living - deserved the fate it received.
What it does mean is that the old way of doing business at many Wall Street firms -- essentially taking huge risks with their shareholders money for the benefit of the employees who worked there - is over and done. Wall Street's next act should be an interesting one.
William Cohan is a former senior-level Wall Street M&A banker. He's also author of The Last Tycoons: The Secret History of Lazard Freres & Co. His new book, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, is published by Doubleday.
