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: Bailout Report

Remembering Bear Stearns 13 Months Later: Has CEO James Cayne Taken Blame?



In August 2007, Bear Stearns CEO Jimmy Cayne wrote to Bear investors. Cayne’s mission that August was critically important, and he knew it. In the wake of the shocking failure of two huge 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 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.

In Cayne’s words, “You can count on us.” Less than seven months later, Bear was purchased by JP Morgan for $10 per share.

A year later, Cayne sang a completely different tune in an interview with Fortune Magazine titled “The Rise and Fall of Jimmy Cayne.” The ex-Bear Stearns CEO revealed that the strength he projected in the summer of 2007 was in fact false strength. Fortune reported that 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.”

The truth according to Jimmy Cayne himself is that Bear’s all-powerful dictator was paralyzed by indecision in the wake of Bear’s hedge fund troubles. Cayne had absolutely no idea how to cope with the company’s financial troubles.

In the CEO’s own words: “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.”

“I didn’t stop it. I didn’t reign in the leverage,” Cayne also admitted to Fortune. Id., Emphasis added. Clearly, Mr. Cayne understood that Bear was overleveraged and blames himself for doing nothing about it.

Conspiracy Theories…

The last widely known conspiracy theory that proved to have any merit was the 1916 poisoning, shooting, and– at last– drowning of mad Russian monk Rasputin.

Still, conspiracy theorists have little to do without a conspiracy of the moment. The fall of Bear Stearns has been embraced by some as their plot du jour. Jimmy Cayne has joined the hunt for a gunman on the grassy knoll.

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.

Bear’s 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. 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 Fortune article is remarkable.

Jimmy Cayne was still the all powerful Oz at Bear Stearns in the summer of 2007. Yet, the former CEO admitted that he was a deer in the headlights following the collapse of Bear’s subprime hedge funds.

Cayne misled the public by writing letters, issuing press releases, and participating in conference calls designed to sure up the shaken confidence of investors, banks, and journalists in Bear Stearns.

Cayne’s concession that he did nothing to right the foundering ship his company had become means that he was in no position to assure the public that things would be fine when he, himself, was so worried about the future that he was frozen by his own doubts. Cayne could not make decisions, and he could not take actions (aside from firing people, which he always did during crises).

Jimmy Cayne withheld material information regarding his own fears that Bear Stearns was on thin ice. He misled shareholders and the public many times in the late summer and fall. Cayne’s material misrepresentations and omissions are securities 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 grossly irresponsible, and probably fraudulent, course of conduct that began at Bear Stearns far earlier than the summer of 2007. It was a pattern characterized by a laser-sharp focus on short-term profitability, an inexcusable overconcentration of (what became) toxic (illiquid) mortgage-backed-securities (MBS) in Bear’s own portfolio, maintenance of startling debt to equity ratios, dangerous reliance on overnight repo financing, a desperate need for a cash infusion, and a truly mind-boggling disregard for risk management.

By March of 2008, Jimmy Cayne had been deposed. Bear Stearns, however, still was on a road to likely destruction. In March, the company was probably even more highly leveraged than it had been the preceding summer. Huge sums of overnight repo lending still were absolutely required to fund Bear’s daily operations. There had been little if any thinning out of the huge positions Bear held in toxic MBS. Despite some false starts and a deal with Chinese bank Citic, the needed substantial cash infusion had not materialized. Risk management appeared no better. The same problems that plagued Bear for so many months were the primary factors in the destruction of the once-respected investment bank.

When Bear’s MBS portfolio was no longer acceptable to secure financing from short-term lenders, Bear Stearns found itself without sufficient funds to operate the company. Combined with a run on the bank, Bear Stearns simply ran out of money and time. The rest is history.

Wall Street litigator Brett Sherman represents individuals and institutions seeking to recover investment losses. Oringially published in his Wall Street Law blog.

Full post as published by Bailout Report on April 30, 2009 (boomark / email).

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