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Spector Ousted by Cayne Over Too Much Bridge, Money (Update1)
By Yalman Onaran



Oct. 3 (Bloomberg) -- Warren Spector had been working at Bear Stearns Cos. for just four months in 1983 when the moment arrived that would make his career. Chuck Ramsey, who was in charge of the company's fledgling mortgage bond desk, had just completed a big trade. William Michaelcheck, a member of the executive committee, was discussing the new endeavor with Ramsey when he made a snap decision.

``He looked around the room and saw Warren Spector standing nearby, and he said, 'Warren, come over here,''' Ramsey recalls. ``Warren walked over, and he says, 'You now work for Chuck.' And that's how Warren Spector got on the mortgage desk.''

Spector took full advantage of the opportunity. By 1990, at 32, he had risen to co-head of Bear Stearns's entire fixed- income operation and was made a member of the company's board. By 2001, he was Bear Stearns's co-president and widely considered heir apparent to the man who had helped guide his career, Chief Executive Officer James ``Jimmy'' Cayne.

In 2006, Spector -- who is ranked as one of the world's top 225 contract bridge players -- earned almost $37 million, making him one of the highest-paid executives on Wall Street.

Then, on Aug. 1, Spector, 49, was called into Cayne's office and asked to resign.

The departure ended a 20-year relationship between the two men in which Cayne guided his young friend and protege to the top rung of the bank and then worked hand-in-hand with him to make Bear Stearns among the most-profitable firms on Wall Street. The investment bank earned $2.1 billion in 2006 on revenue of $9.2 billion. Return on equity, a gauge of how effectively a company reinvests earnings, increased to 18 percent last year from 11 percent in 1995. Its shares gained 41 percent in 2006.

Thrown Overboard

When he was thrown overboard, Spector became the latest Wall Street ``brainiac'' -- as one friend calls him -- to fall from grace. He's also the highest-ranking victim of the subprime mortgage crisis. Cayne, 73, whose own passion for bridge helped forge his friendship with Spector, told him he held him responsible for the implosion of two Bear Stearns hedge funds. The funds filed for bankruptcy in July after losing most of their value. Both invested in financial instruments backed by subprime mortgages.

``No question that mortgage-backed securities made him shine, and it appears that they made him go out the door,'' says Ramsey, 61, who's now CEO of myhomevalue.com, a Web site that prices houses for a fee. ``They caused the rise and the fall.''

Spector's co-president, Alan Schwartz, a 31-year Bear Stearns veteran who had been in charge of investment banking, was named sole president by Cayne in a statement that lauded his ``outstanding judgment and leadership skills.'' Cayne thanked Spector for his ``significant contributions to Bear Stearns.''

A Tainted Image

Spector's mistake was that he was too late to recognize that the hedge funds' losses would taint the larger firm's image as Wall Street's top mortgage trading shop, says James Barrow, president of Dallas-based investment firm Barrow Hanley Mewhinney & Strauss, the seventh-largest Bear Stearns shareholder.

``They went into the hedge fund business, and they hurt themselves,'' Barrow says. ``Spector was the architect of that. It didn't work, and you had to gore the ox, and he was the ox.''

In the two months after news of the hedge funds' troubles broke, Bear Stearns stock lost 25 percent of its value. On Aug. 3, Standard & Poor's issued a ``negative'' outlook on the firm's debt. By Oct. 2, the stock had recovered to $129, creating big paper profits for Bahamas-based investor Joseph Lewis, who announced in a Sept. 10 U.S. Securities and Exchange Commission filing that he had paid $860 million for a 7 percent stake in Bear Stearns, making him its biggest shareholder. That triggered new discussion on Wall Street that Bear Stearns might be for sale.

Income Drops 61 Percent

On Sept. 20, Bear Stearns reported that net income for the quarter ended on Aug. 31 contracted 61 percent, to $171 million, the worst performance among the top five Wall Street investment banks and the steepest quarterly profit decline for Bear Stearns in more than a decade.

Spector's dismissal was driven by more than the hedge funds' failure. His relationship with Cayne had become increasingly tense, say people familiar with the situation. The two men once played bridge and golf together. Cayne attended Spector's 40th birthday party in 1997.

The falling out began in 2004, when Spector made a public statement of support for Democratic presidential candidate Senator John Kerry, the people say. Spector -- who also gave $2,500 to Hillary Clinton's Senate re-election campaign in 2005 -- announced his support for Kerry in a conference call with other Wall Street executives. Cayne, a Republican, rebuked Spector in a letter to Bear Stearns employees for giving the impression that the whole firm supported Kerry.

Political Fallout

``Free speech should not be confused with directly or indirectly using the company to endorse personal political views or agendas,'' Cayne's statement said.

In the last few months of Spector's tenure, the two men avoided each other in the executive dining hall, according to former and current associates. And as the storm over the hedge fund meltdown gathered force in July, Cayne was angry at Spector for spending almost two weeks at a bridge tournament in Nashville, Tennessee. Cayne, who is ranked 611th in the world by the World Bridge Federation, attended the same event for just a few days.

Cayne may also have considered Spector too eager to ascend to the CEO's chair, according to people familiar with Bear Stearns's executive suite politics. When the hedge fund crisis broke in June, the people say, Spector began making decisions without consulting Cayne.

Spector's Authority

``The moth can never get too close to the flame,'' says Bruce Foerster, a former Lehman Brothers Holdings Inc. executive who's now president of Miami-based advisory firm South Beach Capital Markets. ``The No. 2 is always pushing up the line, nudged by the people around him. Spector may have thought he had the cards he needed in his hand, but clearly didn't.''

People close to Spector say that he never felt he was overstepping his authority and that he took the actions he thought were necessary to address the hedge fund crisis, consulting Bear Stearns's executive committee at every stage.

Cayne and Spector were also at odds over Spector's control of a big block of Bear Stearns stock, the people say. In 2004, Cayne changed the rules on how long stock grants could be deferred, prompting Spector, who owned almost 3 percent of the firm at that point, to sell millions of shares.

No Comment

Cayne declined to comment on the firing of Spector or on the evolution of their relationship. On the issue of the stock sales, people familiar with Cayne's thinking say Bear Stearns wanted Spector to cash in some of the stock being held in his retirement fund because, as Bear Stearns shares rose and the value of his retirement plan escalated, it looked like he was earning tens of millions of dollars a year above his base pay.

Bear Stearns, founded in 1923, is the smallest of Wall Street's top five investment banks by revenue and among the least likely to make big bets with its own funds. Cayne, a college dropout who once worked as a scrap-iron salesman, prides himself on being an excellent risk manager. His bank usually sticks to fee-based operations such as clearing trades and underwriting and trading stocks and bonds.

Some 45 percent of Bear Stearns's revenue emanates from its fixed-income divisions, compared with 28 percent at Merrill Lynch & Co. Like many Wall Street banks, Bear Stearns took advantage of the housing boom in recent years and underwrote more mortgage-backed bonds. Mortgages and related securities were responsible for $927 million of Bear Stearns's $4.3 billion in revenue growth from 2002 to '06, the company says. It was the top underwriter of mortgage-backed bonds in the U.S. for '04, '05 and '06, according to Thomson Financial.

Mr. Mortgage

To the housing finance community, Spector remains Mr. Mortgage. ``Mortgages and mortgage-backed securities are among the most-complicated financial instruments out there,'' says Daniel Mudd, CEO of Fannie Mae, the government-chartered mortgage finance company that holds $730 billion in mortgage- related paper. ``Warren is one of the few people that can do mortgage finance analytics in his head.''

Orin Kramer, a friend of Spector's who oversees New Jersey's $82 billion pension fund system, says, ``He's impressively cerebral. There's a widespread and deep respect for his intellect.''

Higher Returns, More Risk

As Spector rose in the organization, he pushed Bear Stearns to move into areas that promised higher returns for higher risk, people familiar with his strategy say. One step was to expand trading in foreign stocks and bonds. From 2002 to the second quarter of '07, revenue from outside the U.S. rose to 20 percent from 9 percent.

In 1993, Spector hired Wendy de Monchaux from France's Bank Indosuez to start a derivatives trading unit. Derivatives are financial instruments whose value is derived from the prices of other assets, such as stocks, currencies or commodities.

Bear Stearns's move into derivatives came over the objections of Alan ``Ace'' Greenberg, the company's CEO from 1978 to '93. In 1992, Greenberg's CEO letter for Bear Stearns's annual report devoted a paragraph to decrying the risks of derivatives. Greenberg, 80 -- also a bridge player -- was succeeded as chairman by Cayne in 2001. He remains head of the firm's executive committee and grills traders about their positions in weekly risk meetings.

Loading Up on CDOs

It was a Spector protege, Ralph Cioffi, 51, who led Bear Stearns into derivatives based on mortgage-backed securities. In 2000, the then 15-year Bear Stearns veteran was named to take over the structured credit sales and production unit. His biggest responsibility was the underwriting and trading of collateralized debt obligations, or CDOs, which slice mortgage bonds into tranches with differing default risks.

In 2003, Cioffi proposed that the firm start a hedge fund based on a similar strategy. With a nod from Spector, Cioffi transferred to the asset management division from the bond desk and set up the High Grade Structured Credit Strategies Fund. The fund bought mostly subprime-mortgage-related CDOs with the highest ratings from Moody's Investors Service and Standard & Poor's.

Cioffi hedged his exposure by taking short positions against a mortgage industry index called ABX, which was expected to fall if mortgage-backed CDOs declined, offsetting losses on the fund's CDO holdings.

The High Grade fund earned investors 46.8 percent from October 2003 to March '07, according to documents sent to investors. With buyers that included insurance firms and oil companies lining up to give him more money to manage, Cioffi started a second fund, the High Grade Structured Credit Strategies Enhanced Leverage Fund, in August 2006. Almost all of the $1.6 billion invested in the two funds came from outsiders. Bear Stearns itself put in just $35 million.

Things Come Apart

In May 2007, things started to come apart. Prices of the CDOs in Cioffi's funds fell and the ABX index he had been using as a hedge rose. The Bear Stearns funds lost money on both sides of the trade because other investors were unwinding the same bet, selling mortgage-related bonds and closing out short positions on the index, driving it up.

The losses were exacerbated by leverage. The funds borrowed up to 20 times investors' capital to enhance profits. If $1,000 in invested capital is leveraged 10 times, meaning another $10,000 is borrowed and invested, a 10 percent loss adds up to $1,100, wiping out the original capital.

In June, banks that had extended loans to the funds, including Goldman Sachs Group Inc., JPMorgan Chase & Co. and Merrill Lynch, demanded that Cioffi increase the collateral he had set aside to protect against losses. Some investors started to ask for their money back. Cioffi was forced to sell some assets to meet those demands, which increased his losses.

Arrogant and Resistant

On June 14, Steven Black, co-head of JPMorgan's investment bank, called Spector to ask that Bear Stearns help out the funds with a loan. Black told associates after the phone call that Spector was arrogant and resistant, arguing that the crisis was exaggerated and that the bankers should let Bear Stearns, with its expertise in mortgage-related securities, resolve the hedge fund problem in its own way.

Bear Stearns in the end loaned one of the hedge funds $1.6 billion. People close to Spector say that when he was first contacted by the hedge funds' creditors, he and Cioffi didn't anticipate that the global market for CDOs would melt down so rapidly. He did all he could to preserve investors' capital in the hedge funds, the people say. Once the troubles surfaced, he met with the Bear Stearns executive committee daily to formulate strategy, the people say, and in the end could do nothing to save the funds from bankruptcy.

`I'm Angry'

On June 15, led by Merrill Lynch, creditors began seizing their collateral from the Bear Stearns funds. Hedge funds that borrow from investment banks typically pledge the securities to guarantee their debt, which the lender can seize if the borrower fails to meet a so-called margin call to increase collateral. The banks' efforts to sell the seized CDOs on the open market pushed prices down even further.

In a June 29 interview with the New York Times, Cayne said he was infuriated at the blow to Bear Stearns's prestige. ``I'm angry,'' he said. ``When you walk around with the reputation for being the most rigorous risk analyzer, assessor, controller, and that's trashed, well, you have got to feel bad.''

Spector felt the heat of Cayne's anger at that Aug. 1 meeting -- by which time Bear Stearns stock had fallen to $118 from $143 on July 2. (It would close as low as $103 on Aug. 15.) People briefed on the meeting say Spector entered Cayne's office assuming it was a routine confab. Instead, Cayne abruptly announced, ``I can't work with you anymore,'' and asked for Spector's resignation.

No Shouting

Shocked, Spector tried to defend his handling of the hedge fund and CDO problems and started to lay out strategies for future action. Cayne would hear none of it. ``I've made up my mind,'' he said. ``The market needs to see we're taking decisive action. I want to show leadership.''

The meeting was over in five minutes, with no shouting. Spector submitted his resignation, and the board accepted it on Aug. 5. Spector's departure was announced to the public later that day.

People familiar with the situation say Spector made a tactical mistake by staying so long at the Tennessee bridge tournament. (His six-member team won by amassing 100 master points, which means they didn't lose a single game.) That gave rivals at Bear Stearns an opportunity to work against him, the people say. Moreover, Cayne was under pressure to name a successor, and, especially in light of the CDO troubles, he didn't want to dub Spector his corporate heir.

Teenage Phenom

Spector, who's married to stage and film actress Margaret Whitton (``Major League,'' ``Nine and a Half Weeks''), first came to Cayne's attention in the late 1980s, when the older man heard he had a bridge champion on his staff.

Spector's mother, Barbara, says her son started playing bridge after watching women play the game at the neighborhood pool. By the time he was a teenager he was so obsessed with the game that after his sophomore year he dropped out of Bethesda- Chevy Chase High School, in a Washington suburb, to play full time for a year.

During his bridge-playing sojourn he amassed the 300 tournament points he needed to be named, at 16, a ``life master,'' and in 1976 was named the Scholastic King of Bridge by the American Contract Bridge League. ``He was a born leader and he was outstanding right from the beginning, in every class,'' says Barbara Spector, a survivor of the Auschwitz death camp who came to the U.S. after World War II.

Chicago MBA

Spector, whose father, Philip, was a Washington-area housing developer, entered Princeton University in 1976 with the intention of majoring in mathematics. After a year, he transferred to St. John's College in Annapolis, Maryland, a small school whose students study the works of the ``great thinkers.'' Spector read the works of Euclid, Plato and Sophocles in the original Greek.

Spector went on to earn a master's of business administration from the University of Chicago. In 1983, he accepted a job offer from Bear Stearns as a trading assistant on the government bond desk. When Spector moved to the mortgage securities desk, Ramsey and his co-chief, John Sites, quickly saw his potential.

``We knew quite frankly that Warren Spector was smarter than us,'' he says. Spector helped his bosses develop new ways of calculating yields on pools of mortgage bonds, Ramsey says. That made them more salable to institutional investors such as pension funds and helped catapult Bear Stearns into its position as one of the largest underwriters of such bonds, he says.

Cash Compensation

As the years passed, Spector was well compensated for his expertise. His cash pay from 1992 through 2006 added up to $228 million. On top of that, $150 million of bonus money was converted into Bear Stearns stock and put in an executive retirement fund called the capital accumulation plan, or CAP.

By January 2004, Spector owned almost 3 percent of the company's stock, more than any individual except Cayne -- partly because, for a number of years, he had put 75-99 percent of his bonus into the CAP program. In the five years ended on March 31, 2001, Spector cashed in $382 million of shares. As of March 31, his stake in Bear Stearns had declined to 0.06 percent.

While he surveys the job market, Spector has time to devote to charitable endeavors. One is St. John's College, to which he gave $7.5 million two years ago to build a dormitory in his father's name. St. John's President Christopher Nelson says Spector, a board member, has led the school's fund-raising efforts for 20 years, challenging other alumni to match his pledges. ``We didn't have any donors of any size before,'' Nelson says.

No Fly-Fishing

Spector is also active in the fight against cancer. After learning in 2001 that his younger sister, Ruth Spector, had leukemia and needed a bone marrow transplant, he set up a New York affiliate of the Florida-based Gift of Life Bone Marrow Registry and began recruiting prospective donors. (Ruth survived after finding a donor in 2002.)

Friends and acquaintances in the banking world say it won't be long before Spector is occupying an executive suite somewhere. (He spent most of August and September at his vacation home on Martha's Vineyard.) ``The last thing Warren will do is practice his fly-fishing,'' says Richard Syron, CEO of Freddie Mac, the government-chartered mortgage finance company. ``He has two big assets: He knows the mortgage market extremely well and is quite a good administrator. A lot of organizations will be lining up to have him.''

Talk of Buyout

Might one of them be Bear Stearns? His ouster and the drop in Bear Stearns's share price have resuscitated talk among analysts that it will be sold -- something that new investor Lewis may be counting on. Erin Archer, an analyst at Minneapolis-based Thrivent Financial for Lutherans, which owns 200,000 Bear Stearns shares, says one likely buyer would be a private equity firm.

``Spector, knowing Bear Stearns well, can go to a buyout firm and say, 'Half these issues aren't as bad as people think,''' Archer says. ``That could help him raise money for a buyout.''

While Cayne has sacrificed his protege to save the firm's image, he himself might end up a victim, says Arthur Levitt, a former chairman of the SEC who is now an adviser to private equity firm Carlyle Group Inc. and a board member of Bloomberg LP, the parent of Bloomberg News.

``The top person always has to take the blame,'' Levitt, 76, says. ``Cayne hasn't escaped blame by firing Spector. We haven't read the last chapter yet.''

As for Spector, one friend thinks politics, which helped sour his relationship with Cayne, could be his next career choice. Spector has been advising Democratic presidential candidates on market conditions, according to Kramer. ``He'd be somebody people would love to have in government,'' Kramer says. One important question would have to be answered first: Does anyone in the Treasury Department play bridge?

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net .

Last Updated: October 3, 2007 01:41 EDT
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