Editor's Note: A large number of Duke University alumni played leading parts in the buyouts of Bear Stearns andWachovia last year, two chapters in the broader Wall Street meltdown. In this excerpt from "Crisis Managers," an article in Duke Magazine, William D. Cohan writes about the school's connections to the chaos, based on his book, "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street." Cohan is a 1981 Duke alumnus.
Early in the morning of Thursday, March 13, 2008, Robert K. Steel, Undersecretary of the Treasury for Domestic Finance, had breakfast with H. Rodgin Cohen, the senior partner of Sullivan & Cromwell, a Wall Street law firm.
The gregarious Steel, a Durham native and 1973 alumnus of Duke University, asked Cohen how things were going. "He said, 'I'm great, but I'm kind of pooped. I was up late, and there are a lot of challenges at Bear Stearns,'" Steel recalls.
That, of course, was an understatement. Cohen, Bear's lead outside counsel, had spent the better part of the night before on the phone from his home in Irvington, N.Y., with the top management at Bear Stearns, including CEO Alan Schwartz, a 1972 Duke grad, helping them grapple with their rising fear that Bear, then the world's fifth-largest securities firm, might not be able to stay in business much longer.
As the night wore on and concerns about Bear's viability mounted, Cohen convinced Schwartz that the situation was so dire that Timothy Geithner, then the president of the New York Federal Reserve Bank, should be informed. Although Geithner was not technically Wall Street's regulator--that job belonged to the head of the Securities and Exchange Commission--he was based in New York and was very familiar with the liquidity issues facing the securities industry. Plus, just six days earlier, he had announced a new $200 billion short-term lending program for banks and securities firms that was meant "to address heightened liquidity pressures" and set to begin March 27.
The next morning, while Cohen ate breakfast with Steel, Schwartz was on the phone with Geithner. "There's a chance we can work through this," Steel says Cohen told him. "But this is pretty unattractive."
Steel ducked into the office of the Secretary of the Treasury, Henry Paulson, and told him about the potentially dangerous situation unfolding at Bear Stearns. "We're not going to know a lot more for a few hours, but let's get some people to start to think about various issues and ways to deal with this," Steel said.
This, in foreshortened detail, is how two Duke graduates of the same vintage --Steel, from Durham, and Schwartz, from Brooklyn -- pulled the curtain back on a financial crisis that approaches the severity of the Great Depression.
More than a few Duke alumni have played central roles in this drama -- among them Steel, chairman of Duke's Board of Trustees from 2005 to 2009, and Schwartz, a current Duke trustee. Others included Steven D. Black '74, Schwartz's fraternity brother, a former member of the Trinity board of visitors, and co-head of global investment banking at JPMorganChase; John Mack '68, chairman and CEO of Morgan Stanley and a current Duke trustee; Michael Alix '83, head of risk management at Bear Stearns, who now works at the New York Federal Reserve Bank; and John Koskinen '61, acting CEO and chair of the board of Freddie Mac and a Duke trustee emeritus.
Their statistically outsized presence is, and will continue to be, delicious fodder for social scientists and historians. (That none of these central figures is female is a reflection of the extent to which Wall Street remains a male-dominated enclave.)
According to Schwartz, the Duke connections may have made this difficult situation slightly easier. "What it creates when you have a relationship is the opportunity to at least know that you can talk to each other and trust that you're being as honest as you can be," he says. "With the Duke guys, you've known them your whole career, and there's just a deeper reservoir that you're tapping into."
Thursday afternoon, March 13, 2008, back on the front lines of the emerging crisis, Steel, Paulson, and Geithner had to figure out whether or not to try to save Bear Stearns. "You really had just a few days to decide," Steel says. "The first decision was whether this was challenging enough to push it into the weekend" -- that is, find a way to keep Bear afloat until the closing bell on Friday, in order to buy some time.
The solution was radical and unprecedented: putting government money "back to back" at JPMorganChase. What it meant was that the Fed would lend money to JPMorgan, which would in turn lend it to Bear Stearns. By law at that time, the Fed could not lend money directly to Bear, a securities firm, but it could lend to JPMorgan, a commercial bank. Given the Treasury's prevailing bias that no one securities firm was systemically important, this was a harder decision than it now seems in hindsight.
"None of us liked it," Steel says. "You had to ask yourself 'What's the best of the series of least appealing alternatives?' If you keep looking for an attractive alternative, you're not going to find one." Through a series of discussions among Paulson, Geithner, and Ben S. Bernanke, the chair of the Federal Reserve Board, the government quickly decided that Bear Stearns had to be saved for the good of the system. "Humpty Dumpty falling was not an attractive outcome, given the market conditions that day," Steel says.
That was when the call went out to James L. "Jamie" Dimon, the CEO of JPMorganChase (and, coincidentally, the father of Julia Dimon '07). Dimon was celebrating his fifty-second birthday at Avra Estiatorio, a midtown Manhattan Greek restaurant, when Schwartz called and urged him to take a serious look at helping Bear Stearns out of its predicament.
Dimon, in turn, called Steve Black, who was enjoying a vacation in Anguilla after months of keeping one step ahead of the financial crisis that had started a year earlier with the meltdown of two heavily leveraged Bear Stearns hedge funds. Black was having dinner with his wife at a restaurant on the island. Dimon told him to get back to New York by the next morning.
After Dimon's call, Black kicked his army into high gear. "That's not to say that when all the stuff started happening on Thursday our first thought was, 'Gee, great. We're going to get to buy Bear Stearns,'" he says. "It was, 'Can we help Bear Stearns and the Fed find a mechanism to keep them open for business so that they don't blow up, which is going to cause everybody a lot of pain?' "
In the end, with the Fed's help -- to the tune of $29 billion -- JPMorgan agreed to buy Bear Stearns for $10 per share (up from $2 per share originally). "When I look back now, I feel better than I did then," Schwartz says. "It felt like somebody had come and set fire to our house, and I felt terrible.
"But then, six months later, a tsunami came through town and blew away all the other houses, and I don't see how, frankly, we would have survived that tsunami. With Lehman going under, with Merrill about to go under, and with Morgan Stanley and Goldman an inch away, I don't see how Bear Stearns was a big enough franchise to survive that kind of storm. The reality is that going through that in March probably, on balance, Bear Stearns' people did better than they would have if we'd survived until September."
Turmoil at Wachovia
As a semblance of normalcy returned to the markets during the early summer of 2008, Bob Steel began to think about what he would do once President Bush's second term ended. That's when he heard that Ken Thompson, the CEO of Wachovia, had been fired. On that same Sunday night, Steel's fellow Duke trustee, Lanty Smith LL.B., '67, called him at home in Greenwich, Conn. Smith, a longtime member of the Wachovia board of directors, had been named interim CEO of Wachovia and was leading the search for a permanent replacement.
At first, Steel told Smith he had no interest and was committed to staying at the Treasury until the new president was inaugurated. He gave Smith the name of five other people he thought could do the job.
But after discussions with his boss Paulson, Steel called Smith, told him he was interested, and quietly resigned from the Treasury. On July 9, Wachovia named Steel its new CEO, with Smith remaining as chair of the board.
That same day, Wachovia predicted it would lose "up to $2.8 billion" when it announced its earnings on July 22. Within a week, the stock hit a 17-year low, which was bad news for Steel, who had just bought $16 million of Wachovia shares. On July 22, Steel announced that Wachovia's actual loss was $8.86 billion.
The bank, reeling from Thompson's ill-timed, $25.5 billion acquisition of mortgage-lender Golden West Financial in 2006, slashed its dividend and cut 6,350 jobs. The stock jumped 27 percent the day Steel announced the restructuring and another 10 percent the following day.
Steel was riding yet another roller coaster, and the bumpy ride would continue into the fall. "I tell people it was a three-act play," he says. "Act I, I show up, and basically we cut the dividend, shrink the balance sheet, and reduce head count, and that generates over the next twelve to eighteen months, $5 to $6 billion of capital. And actually that seemed okay, and the market responded, and people were kind of processing that.
"Act II is the world gets a lot more dangerous for financial-services companies, and the weak swimmers are swimming into the current as opposed to with the current or in a neutral situation. We're a weak swimmer, no question." The final act for Wachovia would come soon enough.
The day after Lehman filed for bankruptcy and AIG was rescued -- to the tune of $85 billion of taxpayer money -- Lanty Smith, the Wachovia chair, called a board meeting so CEO Bob Steel could tell them how he intended to have Wachovia grapple with the rapidly deteriorating financial situation.
Steel says he laid out six strategic options, ranging from "staying the course" to finding a new outside investor for "$10 to $15 billion" of capital to selling the company. "We're going to look at all six," Steel told board members. "I'm not going to be left with trying to pull on strings at the last minute. I think we should be evaluating all six lanes. I didn't want to end up in a corner with no way out." While stating a preference for remaining independent, the Wachovia board authorized Steel to pursue them simultaneously.
Steel had a conversation with Mack about a possible merger of Wachovia and Morgan Stanley. Confidentiality agreements were signed, but that effort soon fizzled. Then, Vikram Pandit, the CEO of Citigroup, called and e-mailed Steel, beginning a furious two weeks of negotiations among Steel, his financial advisers, and a wide range of financial institutions and government regulators around the globe about whether to make an investment in Wachovia, to buy pieces of its business, to buy the whole company, or to put the company into receivership. Wachovia was teetering on the edge.
At about 4 in the morning on September 29, Sheila Bair, the chair of the Federal Deposit Insurance Corp., informed Steel that the FDIC had decided that Citigroup would acquire Wachovia's banking operations and that Steel should rapidly negotiate a deal with Pandit.
At 7:15 p.m. on October 2, Bair called Steel and told him he would be hearing from Richard Kovacevich, the CEO of Wells Fargo, about a deal that was superior to the Citigroup proposal and that would not require government assistance. Since Bair had first told Steel to do a deal with Citigroup and now was telling him to do a superior deal with Wells, Steel listened carefully. "Her enthusiasm was pretty clear," he says.
Steel left New York, where he had been meeting with the Citigroup executives, and headed back to Charlotte, where Wachovia is based. When he landed in North Carolina, his cell phone rang. It was Kovacevich. "'Bob, our board met today, and we decided that we'd like to make a proposal for all of Wachovia with no government assistance for $7 in Wells Fargo stock,' " Steel recalls he said. " 'I'm pushing send, as we speak, on a copy of the merger agreement. It's been signed by me and approved by our board, and this is the merger document that you guys gave us last week.'" Wells had not changed a word in the document.
Steel quickly convened a board meeting to consider the offer but knew "it was a hairy situation." Wachovia had a handshake deal with Citigroup but the Wells offer was financially superior to the Citigroup proposal. "You can see pretty quickly that I'm going to be sued by somebody," says Steel now. "I'm either going to be sued for violating the exclusivity agreement [with Citigroup], or I'm going to be sued by the shareholders for not showing them a better deal. I don't think that's a very hard call. And so we accepted the merger agreement. I signed it and sent it back at about 2:30 that morning."
Going with Wells Fargo
Steel also called Bair at home at 3:30 a.m. and told her the Wachovia board had voted to accept the Wells offer. She suggested that they together call Pandit at Citigroup later that morning. Steel didn't want to wait.
"We're calling him right now," he told Bair. "I'm not going to have Vikram wake up and read in the paper about this. I've known him for 25 years, and he's a first-class guy, and so we should call him right now. And you should be on the phone, too, since you're the person who introduced me to Vikram, and now you've introduced me to Wells Fargo."
Together Steel and Bair called Pandit's cell phone. It was 3:45 a.m. Steel recalls telling Pandit, "There's been a pretty important development I need to fill you in on. If you want to get up and wash your face or something, go ahead, but this is a for-real call." Steel then told Pandit about the Wells offer and the Wachovia board's acceptance of it. According to the proxy statement sent to shareholders about the Wells-Wachovia deal, Pandit told Bair and Steel he believed that Wachovia was in breach of the exclusivity covenants of the Citigroup letter of intent and appealed to Bair to consider "the effect of this development on systemic issues" unrelated to Wachovia.
"He was pretty disappointed -- which is an understatement," Steel says. On January 1, Wells completed the acquisition of Wachovia. Steel is now on the Wells board of directors. He remains entrenched in litigation with Citigroup, which sued him and Wachovia on October 6 over the collapse of the deal.
Steel hopes to resurface somewhere important. Having left Wachovia after the Wells merger, he now spends his time as the head of Grigg Street Capital, a small firm in Greenwich, Conn., and as the chair of the Aspen Institute. He and a group of other investors considered buying Cowen, the investment bank, and taking it private. Another investor ultimately bought it. And his name has been bandied about as a possible successor to Ken Lewis, the CEO of Bank of America (also based in Charlotte), should Lewis retire or be removed. Steel denies being in the running for the job or that a change is imminent.