Financial Times re Bear Stearns, Spector firing
The Financial Times
Markets
Bear falls foul of hedge fund trap
Published: August 10 2007
In 2003, it raised $925m from investors for the High-Grade Structured Credit Strategies fund, run by Ralph Cioffi, who had enjoyed success trading mortgage-backed securities with Bear’s own capital. The fund did well and last year Mr Cioffi raised $640m for another fund, which aimed to boost returns by taking on more debt.
The funds were largely invested in securities rated AAA and AA by credit rating agencies. But as defaults on subprime mortgage soared, the prices of even the highest rated tranches of mortgage-backed bonds crumbled. “This stuff wasn’t triple A. There’s going to be a big debate about this,” said a person close to Jimmy Cayne, Bear’s chairman and chief executive.
Investors reacted by trying to take money out. But the requests added up to much more than the cash Mr Cioffi had available and the funds were closed to redemptions.
The leveraged fund also turned down demands for more collateral from lenders such as JPMorgan Chase and Merrill Lynch, who then tried to call in their loans.
Faced with the difficult decision of whether or not to put its own capital behind the funds, Bear initially opted not to. The investors and banks were sophisticated operators who knew what they were getting into, argued Warren Spector, Bear’s co-president. Eventually, Bear provided a $1.6bn credit line to the high-grade fund that was used to repay lenders.
Some of the banks say Bear’s initial hesitation cost it dear. “It raised questions about Bear’s own liquidity, which risks turning into a full-blown crisis of confidence,” said one senior Wall Street executive. But some insiders say it was a mistake to bail out the lenders at all.
This was echoed by Moody’s, the credit rating agency, which said it was “disappointed” by the decision. “While these steps were taken ostensibly for reputational reasons, Bear Stearns’ reputation had already been tarnished and the financing package failed to prevent the destruction of most of the equity of the high-grade fund.”
Mr Spector removed Richard Marin as head of asset management and replaced him with Jeffrey Lane, a respected former vice-chairman of Lehman Brothers.
But last week, Mr Cayne told Mr Spector, long seen as his heir apparent, that he too would have to go.
Defenders of Mr Spector say that all the key decisions were agreed by Bear’s executive committee. Dick Bove, an analyst at Punk, Ziegel, says Mr Cayne should have considered his own position as chief executive.
People close to Mr Cayne agree that the executive committee backed all his decisions. But given that Mr Spector had overall responsibility both for the hedge fund business and for group risk management, it was right that the buck stopped with him.
Mr Spector “fundamentally mismanaged” the situation, says a person close to Mr Cayne. “He almost blew up the place.” Nobody questions Mr Spector’s intellect. But even before the funds’ collapse, Mr Cayne doubted whether he had the people skills to lead Bear, insiders say. Alan Schwartz, Bear’s head of investment banking, is now sole president and heir apparent.
On top of the blow to its reputation, Bear faces lawsuits from fund investors who will lose virtually all their money.
Some of the banks are also considering legal action. More seriously, in spite of Bear’s efforts to convince the market that it has ample liquidity to ride out the freeze in the credit markets, it is now facing “an old-fashioned funding run” says Brad Hintz, analyst at Sanford Bernstein.
“Trading lines are being pulled and repo lines are being reduced. The Japanese banks aren’t answering Bear’s phone calls, the commercial paper investors are passing on their paper.”
Mr Hintz, a former chief financial officer of Lehman Brothers, says that his analysis clearly shows that Bear can survive such a funding run, just like Lehman did in 1998.
But it will emerge “a little bruised and battered”. As one of its executives admits: “This is the worst thing that has ever happened to Bear Stearns.”
