Schwartz May Be Smooth, But Spector Succeeded In Creating Bear Stearns' Primary Source of Growth

Implications: This article is important because it introduces the reader to Alan D. Schwartz, the new sole President of Bear Stearns, a dominant player in the mbs markets and raises the question of whether he can assure bankers regarding Bear's ability to retain the same access to the same money at the same rates.  The article also questions whether Bear Stearns can be successfully run by an investment banker and whether an outside investor may be solicited or decide to take advantage of Bear's lower stock price and take a sizeable position.  Current market conditions have caused the collapse of two hedge funds run by Bear and a crisis in confidence among its lenders. 

Analysis:    This article raises key issues relevant to the future of Bear Stearns.  First, can Schwartz assure Bear's continued access to credit at rates low enough for Bear's continued profitability.  I believe the answer to this is yes.  As the article points out, Schwartz is a relationship banker not a "mortgage guy" and Wall Street's major lenders are likely to be more receptive to his approach, which will be more diplomatic and conciliatory as opposed to the "bull in a china shop" style which is Bear's trademark style.

The article also raises the issue as to whether Schwartz is the guy who can lead Bear on to continued growth and profitability. Based upon my experience with Bear and the mbs market, I would say no.  Bear is primarily a mortgage house.  Before former Chairman Ace Greenberg made the strategic decision to focus on the mbs markets in the mid 80's, Bear was an unknown and irrelevant player in the capital markets.  Describing Bear's investment banking business as overshadowed by its bond operations is like describing a toy sailboat as being overshadowed by an aircraft carriers.  Warren Spector and a handful of his close colleagues were the impetus behind the gigantic growth of Bear's ability to price, trade and sell mbs which generated huge proprietary income and sales revenue. 

Given recent events, e.g. the collapse of Bear's hedge funds due to valuation and subsequent funding problems, it is highly doubtful that Schwartz or Cayne have the stomach to jump in and seize the gigantic opportunity that currently exists in the mbs market.  Bear, better than any firm with the exception of Lehman, knows how to price undervalued mbs.  They could quickly turn the hedge funds' collapse into a distant bad memory by taking huge positions in downgraded mbs tranches that are trading at unjustified prices.  These bonds have not experienced losses in cashflow, yet the market is discounting them by as much as 50%.   But Schwartz and Cayne have 1) been burned and forcing Spector to leave the firm clearly sends a message to the market that Bear is going to change the way it manages risk and 2) even if they did decide to go for it, Bear's lenders are not likely to stomach more risky mbs purchases.

The third and most crucial issue of course is whether Bear can survive.  I'm confident Bear can survive.  As S&P made clear yesterday, Bear's capital position is more than adequate and they still have their potent posse of mortgage traders; however, will they thrive under Schwartz/Cayne's management?  I'm not sure.  It depends on whether they can trust one of Spector's Lts. to develop and implement a Spector-like strategy -which does not seem likely, at least not until a sufficient (read more than a year) period of time has passed. One thing that would assist Bear in regaining and surpassing its previous dominance is an investor with a huge balance sheet and high risk tolerance  -which means Schwartz/Cayne may no longer be managing Bear.

Finally, a potentially huge factor affecting Bear's ability to thrive: Spector could be dialing up his team at this very moment, convincing them to jump ship and join him in starting a new investment vehicle, designed to take advantage of current market opportunities which he actually helped to create.  I think the only thing stopping this scenario from actually is occurring is ..... funding.  Think that could be a problem for Warren ......at least for awhile.