The tragic implosion of Bear Stearns (BSC) is a saga of missed leadership opportunities that called for candor and courage by the presumed best and brightest in finance. The result: JPMorgan Chase (JPM), led by Chief Executive and Chairman Jamie Dimon, mobilized to fill the leadership void—as the firm's namesake did a century ago during the Panic of 1907, before the creation of the Federal Reserve.
While markets are greatly reassured that the Fed at last is paying attention following its historic Mar. 16 intervention to bring liquidity to Bear Stearns, many wondered why it took Fed Chief Ben Bernanke so long to open the Fed's discount window to investment firms. Where was the Fed last summer when the subprime problem was coming to light? Could Bear have been saved? This past summer, Bernanke was actually predicting—wrongly—that the housing market would recover by the end of 2007, despite continuing bad news from that industry.
Meanwhile, his financial policy partner, Treasury Secretary Henry Paulson, missed the moment. Paulson has been cheerfully defending the Administration's cautious economic assistance package while giving only the most reluctant acknowledgement of an economic downturn. Recasting himself as a Sarbanes-Oxley critic despite his early pivotal endorsement of the legislation while serving as Goldman Sachs' (GS) CEO, last spring Paulson rallied financial leaders to a gripe session on regulation. Goldman research to the contrary notwithstanding, Paulson cited regulation as the chief threat to U.S. capital markets, completely missing the impact of mispriced risk.
Playing Pollyanna Up to the 11th Hour
Responding to questions at the time from PBS NewsHour anchor Jim Lehrer about the already deteriorating risk markets, Paulson commented: "It is my very strong view we are near the bottom and this will be contained as a housing issue as we're fortunate that we have a diverse, healthy economy."
Equally Pollyannish optimism came from the top executives of the imperiled Bears Stearns. Up to the 11th hour, Bear Stearns Chairman and former CEO James Cayne, along with current CEO Alan Schwartz, perhaps blinded by arrogance from past triumphs, did not respond to the danger signs. For eight straight months, they ignored analysts' persistent pleas to deepen their capital cushion as trading partners worried about the firm's liquidity. Over 12 months, the stock fell steadily from $159 a share to $30 a share—the price it was trading at before Dimon snatched up Bear Stearns for $2 a share.
When Schwartz tried to pilot his firm as it spiraled out of control late last week, he was radioing to an empty control tower. Cayne was playing bridge at a tournament in Chicago. This Nero-like distraction repeated his AWOL conduct as CEO during 10 critical days last summer as two of Bear's hedge funds collapsed when he was out-of-contact at a bridge tournament in Nashville. Cayne even bailed out just after the start of a disastrous Aug. 3 earnings call when analysts asked about whether the firm's then-recent 33% stock drop and falling Standard & Poor's credit ratings signaled some liquidity concerns.
Dimon in the Driver's Seat
By contrast, JPMorgan's Dimon was firmly on duty, as is his style. A decade earlier he abandoned a family summer vacation in Europe to help lead the $3.6 billion capital infusion that prevented the immediate collapse of Long Term Capital. (Ironically, Cayne and Bear Stearns refused to help.) His BankOne turnaround triumph a few years later was marked by the same level of engagement. Dimon displayed his personal leadership in the current financial crisis in public and private ways early on. For example, at Paulson's D.C. gripefest last spring, Dimon called the concerns about regulation "parochial" and suggested there were larger risks for the capital markets.
At a June Yale CEO Leadership Summit, Dimon said he learned from his own sober risk-management committee that, "Many risky assets are underpriced and will soon, categorically, across-the-board, be repriced." He challenged the optimistic, fast-recovery predictions of leaders like Paulson and Bernanke. Among his own accurate predictions: The subprime market's ripple effects would extend beyond real estate; many derivative products were inaccurately rated by credit-rating agencies; and there was dangerous unknown leveraging from hedge funds and derivatives.
In the months that followed, Dimon worked to clear JPMorgan's balance sheet, including an exit from structured investment vehicles. Dimon brought to life Louis Pasteur's admonition that, "Chance favors the mind that is prepared." With JPMorgan in strong financial shape, he was ready when the opportunity came about to buy the once-great Bear Stearns.
The Bear/JPMorgan saga is more than a mere lesson about contrasts in leadership styles. Key parties stopped trading with Bear Stearns because they lost faith in its leaders' credibility. Government officials and financiers turned to JPMorgan and Dimon in particular because they trusted his balance sheets, his statements, and his actions. Great leaders know it's essential to build credibility, not just balance sheets and buildings.