By Justin Baer and Ryan Tracy
A major investment bank careens toward bankruptcy. It has $400 billion in assets, 85 years of history and deep ties to every major bank on Wall Street. As word of its troubles spreads, a run begins, sending its stock plummeting.
Ten years ago Wednesday, that was Bear Stearns Cos., a once-storied firm whose excessive leverage had helped put it on the brink. The Federal Reserve tried to limit the damage with extraordinary actions, first extending the firm credit before forcing it into a hasty weekend shotgun marriage to JPMorgan Chase& Co., with $29 billion in assistance.
It was the first time the Fed had intervened with a noncommercial bank since the Great Depression. "Industry participants didn't want to see Bear Stearns go down, and they didn't want to see others go down," says Alan Schwartz, then Bear's chief executive.
Today, those involved with the unprecedented Bear bailout agree it only temporarily staved off a broader meltdown. Its fall was one of the first dominoes in a downturn that months later engulfed all of Wall Street, causing stocks to shed nearly half their value, Lehman Brothers Holdings Inc. to go bankrupt, Merrill Lynch & Co. to sell itself to Bank of America Corp. for $50 billion and American International Group Inc. to take a $182 billion bailout.
The debates endure -- on everything from the causes of the crisis to the government's response. Key players in the bailout, many of whom remain in finance, have spent the last decade arguing about what was done, defending decisions made then and wondering whether it could happen again. The consensus: It would be unlikely for another big firm to get into such trouble, or for the government to orchestrate such a bailout.
Bear, like its rivals across Wall Street, had been struggling with losses from securities tied to mortgages. In the end, though, Bear, which relished its reputation as a scrappy band of outsiders, collapsed because clients and lenders had lost confidence.
Vast amounts of regulatory scaffolding have been erected to try to make sure a firm couldn't ever get into such a situation. There are elaborate crisis-communication plans, tougher capital requirements and "living will" playbooks that are supposed to be followed if a big bank approaches collapse.
The Wall Street Journal spoke with many of the central players that week a decade ago, including then New York Fed President Timothy Geithner and Treasury Secretary Henry Paulson, JPMorgan deal maker Steve Black and Bear's Mr. Schwartz.
Veteran Wall Street lawyer Rodgin Cohen, who helped shape the deal for Bear Stearns, says that if a crippled firm were on the brink today, none of its peers would arrive with a rescue. "Nobody will ever again buy a severely troubled institution," he says. "Period."
Many officials in Washington feel another bailout is just as unlikely. In November, a U.S. senator pressed future Fed Chairman Jerome Powell on whether big banks are still "too big to fail."
"I would say no," Mr. Powell answered.
Yet the new policies for dealing with such crises are untested. Moreover, anger over the public cost of bailing out banks has meant tying the hands of Washington in ways that reduce the sort of improvisation that took place in 2008.
If a large institution got into dire straits, "I believe they would try to allow it to fail," says Mr. Black, the former JPMorgan executive who helped broker the Bear deal. "But if, all of a sudden, the entire dam burst, they might be forced to take a different path."
Risk hasn't vanished from finance. There has been a boom in private credit markets, cryptocurrency exchanges and leveraged-volatility exchange-traded products. At the same time, American consumer debt continues to surge: credit cards, car loans and student debt. Much of the mortgage market -- the culprit in the crisis a decade ago -- has moved outside the banking system altogether.
Today, Mr. Geithner serves as president of New York private-equity firm Warburg Pincus. At the New York Fed and later as Treasury secretary, Mr. Geithner shaped defenses he says now make the financial system better able to absorb shocks. But he says he regrets he was unable to persuade others to preserve the government's authority to backstop the financial system.
"In the extreme case, the defenses fail," he says. "At that point, you are going to lament the weaker firefighting tools."
Federal Deposit Insurance Corp. Chairman Martin Gruenberg says the government's new tools make "the probability of orderly failure today significantly higher than it was during the crisis." He won't guarantee that they would work. "Until we actually do it, I would be cautious about making heroic statements," he says.
Ten years ago, Bear's crisis week began with rumors of liquidity problems following steep losses from mortgage bonds. Mr. Schwartz, the CEO, phoned JPMorgan Chief Executive James Dimon to ask for a simple overnight loan. By that Thursday, Bear's lenders and clients had backed away, and the firm was running out of cash. Mr. Schwartz called Mr. Geithner for more help.
Fearing a Bear-induced panic could spread throughout the banking system, the Fed arranged a $12.9 billion emergency loan routed through JPMorgan. It ultimately agreed to purchase $29.97 billion in toxic Bear assets.
Fed help like that would be illegal today. The 2010 Dodd-Frank financial-regulation law stipulates that emergency Fed lending must be "broad-based" and cannot be "established for the purpose of assisting a single and specific company." Financial firms, like other corporations, are supposed to go bankrupt, not get bailed out.
If regulators and the Treasury secretary assert a bankruptcy would destabilize the financial system, Dodd-Frank provides a new backstop called the Orderly Liquidation Authority. The government would take over the failing firm, wiping out shareholders. After a weekend of work by federal officials, a new company, owned by creditors of the old firm, would open Monday morning. The government would be able lend money to the new company to keep the lights on while the government sells it off in pieces.
That is supposed to prevent a panic because people who had been doing business with the failing firm would know they could continue to do so, at least for a while.
What if orderly liquidation doesn't prevent a panic? In a crisis, problems at one firm can lead investors to "run" to cut their exposures everywhere. Even healthy companies can't get credit, damaging Main Street as badly as Wall Street. In that scenario, there may be little U.S. regulators can do on their own. Congress might be asked to reinstate the bailout authority it took away after 2008.
There is another risk that no amount of legislation can eradicate. In 2008, then-President George W. Bush deferred to leaders at the Fed and Treasury throughout the crisis.
"We would not have gotten through the crisis if I had a president and a boss who cared about the polls or what Congress thought," says Mr. Paulson, the Treasury secretary at the time.
Whether such a hands-off approach would be likely in the current political climate and with the current administration is anyone's guess.
Government improvisation, at least in principle, has been replaced by a playbook. Regulators now practice handling a big firm's collapse and force bankers to prepare.
On Wall Street, some bankers have doubts about whether any government plan written on paper is fast enough in a live crisis. "Drafting big books, massive documents, having big teams -- that's all a good idea," says Gary Parr, a longtime deal maker who advised Bear on its sale to JPMorgan. "But when you have a company get into a liquidity crunch, if things are going really fast, you don't have time to study a book."
On the Friday of Bear's crisis week a decade ago, the company's stock tumbled. Mr. Schwartz, the CEO, got a call from Messrs. Geithner and Paulson. They told him to make a deal to sell Bear by Sunday evening.
Mr. Schwartz heard JPMorgan might be interested, so he set up meetings. As JPMorgan bankers pored over Bear's books, they kept finding new assets that would need to be written down in value. By Saturday, the bankers believed they couldn't bid anywhere close to Bear's Friday closing price of $30 a share, according to people familiar with the matter. Mr. Black called Mr. Schwartz. "This is not a negotiating ploy," he told the Bear CEO. "We're out."
Messrs. Geithner and Paulson, however, persuaded Mr. Dimon to get a deal done by offering government support. Sunday evening, Bear's investment bankers got a call with JPMorgan's final bid: $2 per share. Bear's directors reluctantly approved the deal, which was announced to the world at 7:05 that night. (Later, JPMorgan raised its bid to $10 a share to help win shareholders' support.)
Nearly everyone in charge on Wall Street today, including JPMorgan's Mr. Dimon, says they would never buy a collapsing firm like Bear.
"No, we would not do something like Bear Stearns again -- in fact, I don't think our board would let me take the call," Mr. Dimon wrote in his 2014 letter to shareholders. "These are expensive lessons I will not forget."
In addition to the cost of bringing the two firms together, JPMorgan was saddled with billions of dollars in legal bills and regulatory penalties. Months after the Bear deal, JPMorgan made a similar last-minute agreement to buy Washington Mutual Inc. Of JPMorgan's nearly $19 billion in legal costs from the mortgage crisis, some 70% stemmed from Bear and WaMu, Mr. Dimon wrote.
There were many other such deals in 2008. Wells Fargo & Co. bought Wachovia Corp., Bank of America Corp. acquired Merrill Lynch & Co. and Countrywide Financial Corp., and Toronto-Dominion Bank bought Commerce Bancorp. Today, many of these Wall Street executives say they feel betrayed by the government for hitting them with penalties tied to actions by firms they were pressured to acquire.
These days, a big financial firm rescuing another would also have to consider new restrictions on risk-taking. Banks today must pass regulatory tests before paying out profits to shareholders. In that environment, executives may be more reluctant to buy assets from a desperate seller.
Major changes over the past decade might give a failing firm even less time to survive than Bear had.
Today's stock market is far more driven by computer algorithms than by deal-making traders. That means the reaction to any company's struggles is likely to be quicker and more severe. Wall Street executives say that a firm like Bear might have even less time to solve its problems. MF Global Holdings Ltd., a brokerage run by former New Jersey Gov. Jon Corzine, filed for bankruptcy in October 2011 a week after a drop in its debt rating. In August 2012, a group of financial firms came to Knight Capital Group Inc.'s rescue within days of a software glitch that cost the market maker $440 million.
As the last CEO of Bear Stearns, Mr. Schwartz spent his two-and-a-half-month tenure in the top job scrambling the save the firm. He now works at asset-management firm Guggenheim Partners LLC, where was hired to jump-start the firm's nascent investment-banking business. He has found success recruiting senior Wall Street executives whose firms, like Bear, didn't survive the crisis.
Write to Justin Baer at firstname.lastname@example.org and Ryan Tracy at email@example.com
(END) Dow Jones Newswires
March 13, 2018 12:55 ET (16:55 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.