JIM LEHRER: Next, the house of cards that helped bring down Wall Street. This was a week dominated by the AIG story and the executives who took huge risks with tens of billions of dollars.
Long before the AIG story began to play itself out, there were foreshadowings on Wall Street. Ray Suarez has our conversation.
RAY SUAREZ: It was just over a year ago that the revered Wall Street and global investment bank and brokerage firm Bear Stearns collapsed. That meltdown proved to be the first of a flood of bank failures and a precursor to the worst global financial crisis since the Great Depression.
William Cohan is a former Wall Street investment banker-turned-writer and author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street,” in which he follows the history and decline of Bear Stearns.
And you begin the story sort of at the end of the story, with how this all happened, a very thorough tick-tock of how men — mostly men…
WILLIAM COHAN, author, “House of Cards”: Mostly men.
RAY SUAREZ: … raced to stop this collapse from happening, and then at some point had to let it happen.
WILLIAM COHAN: Well, you know, one of the challenges of writing a book where people think they know the ending — and everybody, of course, does, I mean, the ending doesn’t change — but, you know, my goal was to try to explain to people how and why this happened, not only what happened those last 10 days, but take the readers back so they could understand how Bear Stearns found itself in the position where something like this could happen, which…
Transformation on Wall Street
RAY SUAREZ: Remind how that was.
WILLIAM COHAN: Well, there were a number of factors, but, first of all, the first key thing was the incentive system on Wall Street. You know, human beings are relatively simple. You just reward them for something, and they will do it.
And on Wall Street, the reward system was: Just do as much as you possibly can -- generate as much revenue as you can as quickly as you can.
And when the firms on Wall Street in the late '60s, early '70s went from being private partnerships to public companies, in private partnerships, they had -- they shared the profits and they shared the liability. So if somebody did something wrong, then they all shared greatly in that mistake.
But when they transformed themselves into public companies, all the benefits went to the people on Wall Street who worked there and all the liabilities went to the shareholders.
And as a result, people on Wall Street began taking bigger and bigger risks with their shareholders' money, knowing full well if the bet paid off they would get a nice bonus early on, and nobody would take it from them. And if the bet didn't pay off, well, that problem would rest with their shareholders.
Now, how do I know this? Because I worked on Wall Street for 17 years. And I am myself a beneficiary of that financial incentive system. And while I was just an M&A banker and didn't take any risks with the firm's capital, all around you could see what people were motivated to do.
And it just became unhealthy and resulted in any number of crises that we've lived through for the past generation, whether it was the crash of '87, Internet IPO bubble, emerging telecom debt bubble, and now mortgage-backed securities.
Overnight financing market
RAY SUAREZ: Well, you mentioned that you knew this world from the inside as a mergers and acquisitions guy, but were there points when you were telling this story where even you couldn't believe what people had done and were doing?
WILLIAM COHAN: Yes, absolutely. I mean, first of all, the fact that Bear Stearns would allow itself to be so concentrated in mortgage-backed securities and other risky securities that it manufactured and sold to the marketplace, and over time, as the selling of these securities slowed down and the buyers weren't there, the inventory on their balance sheet of these securities continued to rise, until they were stuffed to the gills with these securities.
The other thing, the real revelation for me, was how Wall Street financed itself. Rank-and-file people on Wall Street don't understand how Wall Street finances itself. They understand how their clients finance themselves. You know, you get a 10-year loan, and you pay interest, and you pay the principal back over time.
On Wall Street, the reason this whole thing was so precarious is because, on Wall Street, firms like Bear Stearns and Lehman Brothers financed themselves in what was called the overnight financing market. They got short-term loans that were inexpensive and the collateral for those loans was the inventory of these mortgage-backed securities that they built up on their balance sheet.
So as those securities lost value during the first quarter of 2008 -- it really began in the spring of 2007, but all through that year -- these securities lost value, and nobody wanted to buy them, and nobody wanted to sell them. And these were used as the collateral for these overnight loans.
Bear Stearns would get $75 billion of overnight loans from people like Federated, investors in Fidelity Investments, to finance their business. Well, at that last week in March, Fidelity and Federated said, "We don't want to take that collateral. We don't want it."
Bear Stearns executives
RAY SUAREZ: That was the striking part, that even when the people at the top of the pyramid at Bear Stearns were taking these huge risks, they were very heavily tied in to a bunch of other companies that had a very strong interest in not letting them go down. Yes, Bear Stearns was at the edge of the cliff, but they had a rope tied to their ankle and everybody else's ankle.
WILLIAM COHAN: Yes, as Wall Street became much bigger, much more capital involved, much more global, the relationships became much like a spider web. And that's why this fateful day in March a year ago, the Fed, the Treasury, and the New York Fed decided that, you know, Bear Stearns was, quote, "too big to fail," and they didn't want to risk an out-and-out liquidation of Bear Stearns, and the effect that that would have on all their, quote, unquote "counterparties," all the customers they did business with.
Now, we all know that they changed their view on that when it came to Lehman Brothers, although the circumstances were different, and they changed it again when it came to AIG. So, you know, they were testing all sort of theses as they went along. Unfortunately, we were the losers in all of this.
RAY SUAREZ: It is stunning that the people at the top had to call away one of the primary personalities who built Bear Stearns over the last generation away from the card tables to talk about this. And even then, he sort of bugged out of one conference call and went back to his bridge game.
WILLIAM COHAN: Well, you know, the book is called "House of Cards" because it's a, you know, double entendre on the fact that three of the top five executives at Bear Stearns, Jimmy Cayne, who was the CEO from 1993 until January of 2008, Ace Greenberg, who was the CEO from 1978 to 1993, when Jimmy Cayne, you know, deposed him, and Warren Spector, who was the co-president for much of the last decade and had built the fixed-income business at the firm, all three of them were world-class bridge players.
Jimmy Cayne was a national bridge champion. And, in fact, he got hired at Bear Stearns by Ace Greenberg because Ace was aware of Jimmy Cayne's bridge prowess.
At the time Jim interviewed with Ace, he had been a bonds salesman at a small municipal bond house in New York called Leventhal and Company, but his real passion was for playing bridge, and he played professionally for a time, and then he played, you know, as his avocation, and he played with all these wealthy Wall Streeters, like Larry Tisch, who helped Jimmy Cayne succeed at Bear Stearns.
And when they had that interview, Ace Greenberg said, "I know you. You're a great bridge player. I want to become a better bridge player, too. Come to Bear Stearns." And that's what happened. Jimmy Cayne taught Ace Greenberg to be a better bridge player.
Greedy decisions lead to collapse
RAY SUAREZ: What should the common reader, who's not a business specialist, but wants to know what happened to the world over the past year, take away from this story? And what's cautionary about the story?
WILLIAM COHAN: Well, I like to say that this is sort of the Rosetta Stone of the crisis. If you want to understand what happened in this financial crisis, if you understand what happened at Bear Stearns, you can understand it.
Part of it is that relying on that overnight financing market that I talked about before. Part of it is building this manufacturing plant for these mortgage-backed securities. And the two of them were sort of like this yin-yang relationship and both took each other down, because the collateral -- these mortgage-backed securities -- were used for the collateral for the overnight financing market. And when the overnight financers didn't like that collateral any more, they pulled the plug.
The other very, very important thing is just how personalities drive what happens here. I mean, the story of Jimmy Cayne and his interrelationships with Ace Greenberg and Warren Spector and Alan Schwartz, who became the CEO after Jimmy retired in January of 2008, were integral to what happened here.
So when some of these people say, you know, it was a tsunami that hit them and they don't know what to do and they wouldn't have known what to do differently, you know, when they go up in front of Congress and testify about what happened here, the truth is, they made decisions, year after year, multitudes of decisions -- like not to expand in Europe, not to buy an asset management company, not to get bigger in investment banking, but to concentrate in the fixed-income division, because they were making so much money and the top executives were getting paid such huge compensation that they just didn't think about the consequences of what they were doing or, if they did think about it, they knew they didn't want to change it because it was too good.
RAY SUAREZ: The book is "House of Cards." William Cohan, thanks a lot.
WILLIAM COHAN: Thank you for having me.