House of Cards

(Literary Masterpieces, Volume 1)

On March 5, 2008, an investment analyst in Florida posted an opinion on his Web site that Bear Stearns & Co., the fifth largest investment bank in the United States, was effectively insolvent. On the surface, this seemed strange. In 2007, Fortune magazine praised Bear Stearns as the most admired securities firm in the United States. The company had an $18 billion cash reserve and was about to announce a profit for the previous quarter. Nevertheless, the analyst was right. Ten days later, the eighty-six-year-old firm no longer existed. Fearing that its bankruptcy might threaten the stability of the global financial system, the Federal Reserve and the U.S. Treasury forced the company to sell itself to JPMorgan Chase for a pittance.

The first third of William D. Cohan’s House of Cards: A Tale of Hubris and Wretched Excess on Wall Street consists of a riveting, day-to-day, blow-by-blow account of those dramatic ten days. The next three hundred pages examine the history of the firm, describing its success and the reasons that it found itself so badly exposed in the early days of the economic downturn of 2008.

The Florida analyst was not the only one to view Bear Stearns with suspicion. Rumors that the firm faced a liquidity crisis swept Wall Street. Oblivious to the impending storm, the company’s own top management left town. On March 6, president and chief executive officer (CEO) Alan Schwartz went to a media conference in Palm Beach, Florida; chairman of the board James A. Cayne, a championship-level bridge player, was in Detroit taking part in a major tournament.

On Friday, March 7, a European bank informed Bear Stearns that it would no longer provide the company with short-term financing. This was a major blow because investment banks depend on short-term loans to finance their operations. Often, these are overnight “repo” (repurchase agreement) loans, in which banks such as Bear Stearns “sell” securities to a lender and promise to buy them back the following day with interest. Normally, these loans can be renewed easilyif the borrower seems certain to repay.

Readers of House of Cards need not worry if they do not understand the various financial termssuch as repo, “CDO” (collateralized debt obligation), and credit default swapwith which the book is strewn. On the evidence of this book, neither did financial experts at the biggest investment houses on Wall Street. At Bear Stearns, the operating capital of the firm depended on short-term (mostly one-day) loans. These loans often used subprime mortgage bonds as collateral. No one seemed aware of or concerned about the risk that the firm could become insolvent in just twenty-four hours if its reliability was questioned.

On Monday, March 10, Bear Stearns assured customers that it faced no problems; the firm’s statement, however, only served to increase market rumors and anxiety. Hedge funds began withdrawing cash from the bank; lenders demanded more collateral. On Wednesday, CEO Schwartz, interviewed on television from Palm Beach, uttered vague reassurances that convinced no one. The run on the bank continued. At the start of the day on Thursday, March 13, the firm had $18 billion in cash. At the close of trading, this amount had dwindled to $2 or 3 billion, not enough to open the next day. Incredibly, Thursday night was the first time the chairman of the board, busy playing bridge in Detroit, or any other member of board of directors was informed that the firm had a problem.

Fearful that the failure of Bear Stearns would set off a worldwide market panic, the Federal Reserve Bank of New York and JPMorgan Chase advanced sufficient cash for Bear Stearns to open on Friday. News of the rescue brought increased pressure on Bear Stearns. The U.S. Federal Reserve and the U.S. Treasury concluded that Bear Stearns needed to sell itself to another firm. These institutions agreed to guarantee $30 billion of Bear Stearns’s assets, but they insisted that the deal had to be completed before Asian markets opened on Monday (7:00 p.m. on Sunday night in New York).

The brokerage firm hired to find a buyer (and paid $20 million for its efforts) could locate only one bank willing to take on the burdenJPMorgan Chase, whose president, James L. Dimon, had long coveted Bear Stearns’s bond brokerage business. Dimon was willing to offer $10 per share, but Secretary of the Treasury Henry M. Paulson insisted the price be reduced to $2 so that the government could show it was not rewarding misbehavior. After furious maneuvering by Bear Stearns, the price went back to $10.

In January, 2007, Bear Stearns stock had sold for...

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House of Cards Bibliography

(Literary Masterpieces, Volume 1)

The Boston Globe, March 28, 2009, p. G8.

BusinessWeek, March 16, 2009, p. 70.

The Economist 390, no. 8621 (March 7, 2009): 89.

Los Angeles Times, March 6, 2009, p. D1.

The New York Review of Books 56, no. 17 (November 5, 2009): 54-57.

The New York Times, March 10, 2009, p. C4.

The New York Times Book Review, June 14, 2009, p. 10.

Newsweek 153, no. 12 (March 23, 2009): 16.

Reason 41, no. 3 (July, 2009): 48-53.

The Wall Street Journal, March 6, 2009, p. A13.

The Washington Post, March 22, 2009, p. B7.