How Bear Stearns Mess Cost Executive His Job - WSJ.Com

How Bear Stearns Mess Cost Executive His Job - WSJ.com http://online.wsj.com/article_print/SB118634436359588576.html

August 6, 2007

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On Wednesday James Cayne, the 73-year-old chief executive of Bear Stearns Cos., summoned his top lieutenant to his smoky, dimly lit office in midtown Manhattan.

The big securities firm Mr. Cayne had led as CEO for 14 years was under attack. Two of its mortgage-related hedge funds had blown up, costing investors more than $1 billion, and its stock was under siege, down 27% this year alone. The way Mr. Cayne saw it, Warren Spector, Bear Stearns's co-president and the person most often cited as his likely successor, deserved some of the blame.

He told Mr. Spector he had lost confidence in him. "I think it's in the best interests of the firm for you to resign," Mr. Cayne told Mr. Spector, people familiar with the conversation say.

Mr. Spector was taken aback, and responded that he'd been working hard to address the firm's problems, according to one of these people.

That conversation ended the close partnership between the two Wall Street veterans, a connection forged years earlier by a common love of bridge, but one that had become strained. Mr. Spector, a 49-year-old former mortgage-securities trader, has become Wall Street's highest-profile casualty in the burgeoning subprime lending fiasco. What had started as a narrow problem in a small corner of the U.S. housing market -- lending to risky borrowers -- has become a big problem for Wall Street.

The trouble at Bear Stearns has spooked investors. Bear Stearns has long been known as one of the most astute risk managers on Wall Street. Its problems come despite repeated assurances from Wall Street bankers that they have a handle on the booming market for mortgage securities. Bear Stearns, which has a huge mortgage business but a less diverse mix of other business than its investment-banking peers, has been the hardest hit. Its stock has fallen 28% since the beginning of June, and 6% on Friday

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alone. A Friday afternoon conference call intended to quell investors' fears about Bear Stearns's profitability attracted 2,200 listeners.

Mr. Spector's ouster may not allay those concerns. It leaves the company without a clear succession plan and without the services of a mortgage and trading expert. While Mr. Cayne is deeply involved in running Bear Stearns, he had left much of its day-to-day operation to a pair of lieutenants -- investment banker and co-president Alan Schwartz and, until last week, Mr. Spector. Mr. Cayne had been comfortable enough with their stewardship that he didn't come into the office most Fridays in the summer, preferring to stay at his home in New Jersey.

Bear Stearns's 13-member board met yesterday afternoon to formalize Mr. Spector's departure. For now, the firm will have a single president: Mr. Schwartz, a seasoned rainmaker who has advised on big mergers but doesn't have the trading experience of Messrs. Spector or Cayne. Jeffrey Mayer, co-head of global fixed income at Bear Stearns, will replace Mr. Spector on the executive committee. "There is a depth of talent in our senior management team," Mr. Cayne said yesterday in a prepared statement.

Bear Stearns has told investors that it's "solidly profitable" and that it made money during the market gyrations of both June and July. The firm said that in recent months it has moved to secure more stable financing by replacing some of its commercial-paper holdings with longer-term loans.

"They have weathered a lot of storms before, but this is a...tough hole to dig out of," said Glenn Schorr, an analyst at UBS AG. "They have funding to carry them for a while."

Nevertheless, Wall Street has been buzzing with speculation that the firm will need to seek a strategic investor. In 1987, investor Warren Buffett bought a large stake in Salomon Brothers Inc. as it struggled to fend off unwanted offers, and he later served as interim chairman to restore confidence during a crisis. Last year, Bear Stearns held talks with China Construction Bank Corp. about taking a minority stake, which would have given Bear Stearns a larger capital base and a foothold in China. But the talks fizzled after the then president of CCB, Chang Zhenming, left the bank.

Bear Stearns's Los Angeles-based vice chairman, Donald Tang, has continued to pursue the idea with other entities such as China Citic Group, according to people familiar with the matter. A person close to Bear says the firm is only interested in a joint-venture partner. But following the Chinese government's $3 billion investment in private-equity firm Blackstone Group, other Wall Street firms have been seeking similar ties, which gives Chinese entities more attractive alternatives than Bear Stearns.

Bear Stearns's troubles started in the housing market, where it had developed a lucrative business originating mortgages and packaging them into securities that were sold to investors and traded. In 2006,

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home prices were beginning to taper but "subprime" borrowers with sketchy credit continued to get mortgages. By the second half of that year, however, late payments and defaults were rising, shaking the subprime market, and the picture worsened after the new year. Home prices also were starting to slip, raising fears of a housing bust. At Monday meetings of Bear Stearns's executive committee, the housing market became a frequent point of discussion.

The committee didn't foresee trouble at two internal hedge funds run by Ralph Cioffi, a former mortgage-bond salesman who had been with Bear Stearns since 1987 and was a close colleague of Mr. Spector's. In 2003, Mr. Cioffi had approached his superiors about using the firm's own capital to buy and sell securities in a portion of the fixed-income market that included collateralized debt obligations, or CDOs. Some CDOs are based on pools of mortgage loans. He was successful enough that, at the end of that year, Bear Stearns's hedge-fund committee allowed him to open his own fund as part of the firm's asset-management unit.

His fund, called the High-Grade Structured Credit Strategies fund, raised about $925 million from investors and invested in CDOs. For several years, it notched positive monthly returns. Last year, he launched a second fund with roughly $640 million in investor capital. He loaded it with debt to magnify returns.

This spring, as the housing market weakened further and subprime defaults mounted, results began to slip. Bear Stearns officials didn't worry much at first. Mr. Cioffi's investments were considered by rating agencies to be high-grade investment vehicles, and their valuations had remained largely intact.

But in May, brokerage firms that had sold CDOs to Mr. Cioffi began slashing the prices, or "marks," they had previously put on those securities, leaving the two hedge funds with double-digit paper losses. In early June, some investors in the more leveraged fund asked for their money back. Because their requests added up to about $300 million -- more cash than Mr. Cioffi had on hand -- redemptions were frozen.

Bear Stearns's stock began dropping in value, and the executive committee started meeting nearly every day to discuss what to do. To the committee, it looked as though the enhanced-leverage fund had little chance of surviving, but that the first fund might be salvaged. By mid-June, the enhanced-leverage fund had missed margin calls -- requests for additional cash and collateral -- from lenders including Merrill Lynch & Co. and J.P. Morgan Chase & Co. The lenders wanted to be made whole.

Some Wall Street executives were pressuring Bear Stearns to stop the bleeding. Initially, the firm's executive committee balked. Bear Stearns executives felt they shouldn't feel obligated to lend money to a fund whose operations were separate from Bear Stearns's, and whose investors were knowledgeable about the risks. On the afternoon of June 14, J.P. Morgan's investment banking co-chief, Steven Black, and his top risk officer had a tense phone call with Mr. Spector, in which the lender urged Bear Stearns to give the fund some emergency credit, participants in the call say.

Calling the J.P. Morgan executives "naïve," Mr. Spector said Bear Stearns was the resident expert in the mortgage business, recalls one participant, and that the lenders should back off.

Early that evening, J.P. Morgan sent an in-house lawyer to Bear Stearns's headquarters with an official default notice. But a Bear Stearns receptionist told the lawyer that the firm was closed for business, and that the documents couldn't be accepted, people familiar with the matter say.

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The blow to Bear Stearns's reputation, however, caused the firm to reverse course. Late the following week, after hearing a presentation from Bear Stearns's in-house mortgage team suggesting that the older fund might still contain value, the firm's executive committee authorized a secured loan to the less-leveraged fund of up to $3.2 billion. The fund ended up borrowing $1.6 billion, which it didn't repay entirely, leaving Bear Stearns's loan officers to seize the collateral remaining in Mr. Cioffi's fund. Bear Stearns could lose much of the $1.3 billion the fund still owes it, public filings indicate.

Because the asset-management division reported to him, Mr. Spector was under fire as well. He replaced the chief of that division with Jeffrey Lane, a money-management veteran who had once run Neuberger Berman LLC. Working long days and nights and seeing little of his wife, Mr. Spector told friends he was chagrined about the crisis and that he understood that the stakes were high.

Nevertheless, Mr. Spector had agreed months earlier to play with partners in a national bridge tournament in Nashville, Tenn. So he flew there in mid-July to compete. With Bear Stearns's shares reeling and concerns about the firm's management mounting, he spent about a week at the tournament, rising early to work the phones in his hotel room and jumping into the game in midafternoon. Along with his partners, Mr. Spector won the tournament. Still Mr. Cayne, who also played in the Nashville competition, was steamed that his lieutenant had been away from the office, according to people familiar with his thinking.

Years earlier, it was Mr. Spector's bridge-playing skills that had helped bring him to the attention of Mr. Cayne, a former scrap-iron salesman who had made his name as a stockbroker.

Mr. Spector, who grew up outside Washington, had won the title "king of bridge" in a national youth contest. After graduating from Bethesda-Chevy Chase High School in 1976, he attended Princeton, then switched to St. John's College, a small school in Annapolis, Md.

During his junior year, Mr. Spector wrote to Alan "Ace" Greenberg, then managing partner of Bear Stearns, to ask for a summer job. He got an offer, but turned it down because he couldn't afford to live in New York on $125 a week. Several years later, after graduating from business school, he contacted Mr. Greenberg again. This time he accepted a job offer.

He started on the firm's government-bond desk, where he helped establish the metrics and systems Bear Stearns uses today to research and trade mortgage-backed securities.

By 1987, two years after Bear Stearns went public, Mr. Spector was one of the best-paid people at the firm. Around that time, Mr. Cayne, who had not yet become CEO, was reviewing some compensation figures, and Mr. Spector's name rang a bell. He picked up the phone and dialed Mr. Spector. "Are you the Warren Spector that was the king of bridge?" he asked. Mr. Spector said he was, and Mr. Cayne invited him for a chat.

In 1990, Mr. Spector became a Bear Stearns director, and a few years later, he was named one of two people to run fixed income. In 1995, Mr. Spector's partner in overseeing the group, John C. Sites Jr., left amid speculation that Mr. Spector had pushed him out. Mr. Sites did not return calls for comment.

Mr. Spector, who wears black-rimmed glasses and maintains a trim physique, kept a relatively low

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profile on Wall Street. He and his wife, Margaret Whitton, a former actress who had a supporting role in the movie "Nine ½ Weeks" and played the vixenish wife of a CEO in the 1980s Wall Street parody "The Secret of My Success," have raised money for various charities, including for a hospital on Martha's Vineyard, where they own a beachfront home.

In recent years, Mr. Spector and Mr. Cayne butted heads over several issues. They didn't see eye to eye on Mr. Spector's wish to trade derivatives -- securities whose values are tied to stocks and other products -- on behalf of Bear Stearns customers. They disagreed about whether Bear Stearns should have a gym in its Madison Avenue building. (Mr. Cayne eventually agreed to add one.)

In 2004, Mr. Cayne publicly rebuked Mr. Spector for speaking on behalf of Democratic presidential candidate John Kerry, to whom Mr. Spector had donated money. (Mr. Cayne discourages Bear Stearns employees from making public statements about politics.) "If any of you were upset or offended by these press reports, please accept both his and my apologies," Mr. Cayne wrote in a memo to employees that chided his deputy.

Around that time, there was also tension over Mr. Spector's pay, due to his practice of deferring his annual compensation for a period of years, people familiar with the matter say. The firm allowed such deferrals, but Mr. Spector's total deferrals were becoming expensive for the firm, Mr. Cayne and some other executives felt. Last year, Mr. Cayne made $33.85 million and Mr. Spector took home $32.1 million, according to regulatory filings.

--Henny Sender and Robin Sidel contributed to this article.

Write to Kate Kelly at [email protected] and Susanne Craig at [email protected]

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