The Five Dumbest Things on Wall Street This Week

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The 5 Dumbest Things on Wall Street: May 9

Nat Worden

1. Cayne and Ace

In Hollywood, there was Jack Lemmon and Walter Matthau. In Washington, D.C., there's George H.W. Bush and Bill Clinton. On Wall Street, the new odd couple is Bear Stearns (BSC Quote) Chairman Jimmy Cayne and his mentor, Alan "Ace" Greenberg.

Despite their rivalry at the highest echelons of investment banking, Cayne and Ace are headed to their golden years as dear old friends, and while the firm's days are numbered, the hijinks and tomfoolery between these two are only beginning.

We wouldn't know about this brotherhood if it weren't for Ace's plans to pen a sentimental memoir in tribute to his pal. In a spirit of goodwill, he was willing to share a few nuggets with The New York Times to whet the public's appetite. It sounds like a cross between Mitch Albom's Tuesdays With Morrie and Tim Russert's Big Russ and Me.

Ace speaks poignantly about meeting Cayne at a bridge tournament in 1969 and hiring the young up-and-comer as a stockbroker at Bear. Cayne would go on to become the firm's CEO in 1993 and wrest the chairmanship away from his mentor in 2001. As fate would have it, Cayne would be famously absent from his duties, competing at a bridge tournament, last summer while the firm began to unravel.

Facing a bankruptcy that could have sparked a meltdown in the global financial system, Bear called on the government for help, and the Federal Reserve promptly bailed out the firm and orchestrated its sale to JPMorgan Chase (JPM Quote). Its stock fell from over $87 at the beginning of the year to $10.

Cayne lost nearly $1 billion in the carnage, since he was heavily invested in the firm, and he has retreated into seclusion amid harsh public criticism. Ace had already cashed out the bulk of his stake in Bear before disaster struck, and he will stay on at JPMorgan as vice chairman emeritus while he spins yarns about his glory days and basks in the spotlight.

As a charming practical joke, Ace actually charged his chum a commission of $77,000 for the sale of his 6 million shares in Bear, a rate far above the maximum $2,500 commission that employees pay for a single trade, according to the Times. That was good-natured payback for the ribbing that Cayne used to heap on his pal's nickname, making anyone who said the name "Ace" in his presence pay him $100.

In a hilarious misunderstanding between the two, Ace actually contemplated leaving Bear once, and Cayne mistakenly thought it was because he felt underappreciated. Ace will set the record straight in his book and show his sensitive side, telling The Times that he was depressed because his dog was sick.

"He had not been performing well in dog shows," said Ace.

Now, Ace says he warned Cayne about the mortgage mess -- a claim that is disputed by at least one fellow member of Bear's executive committee. While Ace blames Cayne for the disaster, the firm's CEO, Alan Schwartz, is busy blaming short-sellers and market rumors.

Nothing, however, can get in the way of this iron-clad friendship, and Cayne and Ace are still delighted to see each other around the office.

"I don't understand why he comes in," Ace told the Times. "He is not employed here anymore."

Dumb-o-meter score: 95. Bear is gone, but Ace remains his brother's keeper.

2. Our Fearless Leaders

If it wants to help the financial markets, the Bush administration may want to stop making public pronouncements about how healthy they are.

This week, Treasury Secretary Hank Paulson inspired confidence by proclaiming in an interview with The Wall Street Journal that "the worst is likely to be behind us" in Wall Street's credit crisis.

"There's no doubt that things feel better today, by a lot, than they did in March," Paulson said, pointing to the Federal Reserve's decision to rescue Bear Stearns and to provide liquidity to other investment banks as "an inflection point" for the markets.

Paulson did concede that there will be "bumps along the road," and the market confirmed this shortly after the interview's publication. The Dow Jones Industrial Average dropped more than 200 points.

Hopefully, the selloff was short-lived, but the response to Paulson's optimism was remindful of the Bush administration's classic performance back on Aug. 8, 2007, at the outbreak of the credit crisis.

With his economic advisers gathered soberly around him, President Bush said the turmoil in the housing sector would end with a ''soft landing'' and would not damage the larger economy.

''I believe that markets ultimately look at the fundamentals of any economy,'' said Bush. ''And the fundamentals of our economy are strong. Inflation is down. Real wages are increasing. The job market is a strong job market. People are working. Small businesses are flourishing."

The Dow shed 387 points that day.

Dumb-o-meter score: 91. Does Wall Street have the makings of a new contrarian indicator here?

3. No Country for BofA

Ask not what Bank of America (BAC Quote) can do for its shareholders. Ask what BofA can do for America.

For the company's shareholders, time is running out to convince management not to buy Countrywide Financial (CFC Quote), the housing bubble's version of Enron.

BofA signaled this week that it will plow ahead with the deal, despite burgeoning signs of continued losses at the mortgage giant and legal troubles as well.

BofA's shareholders got a glimmer of hope when their company revealed in a regulatory filing that it wouldn't commit to guaranteeing Countrywide's debt. This led Standard & Poor's to cut Countrywide's credit ratings, citing the uncertain status of its creditors.

That prompted a chorus of equity analysts to advise BofA to wriggle out of the star-crossed engagement.

Last week's earnings report from Countrywide demonstrated clearly that the carnage of the mortgage debacle is spreading far beyond the subprime category. In its portfolio of option adjustable-rate mortgages, known as option ARMs and classified as prime loans, 9.4% were at least 90 days overdue, up from 1% a year before.

Option ARMs give borrowers the option during the first few years of the loan of making minimal payments, covering no principal and even less interest. Choosing that option means the loan balance increases, and eventually borrowers face a spike in monthly payments. Many borrowers took on those loans with the intention of refinancing before their payments go up, but now that home prices are in decline, that option is no longer feasible.

Meanwhile, this week's hearing before the Senate Judiciary Subcommittee on Administrative Oversight and the Courts provided a whiff of the legal troubles that may be in store for Countrywide amid ongoing probes from the Justice Department and elsewhere. The company was accused of inflating and inventing fees to charge mortgage borrowers in bankruptcy court, with what Sen. Chuck Schumer (D., N.Y.) called a "vulture mentality."

Steve Bailey, chief executive for loan administration at Countrywide, admitted that the company had made some mistakes, but he said the practices in question were never intentional. He claimed that such mistakes were identified at only 1%, or 650, of the 65,000 cases Countrywide has in bankruptcy.

Schumer noted that in the Western District of Pennsylvania alone, 300 cases have been identified involving trouble with Countrywide.

"If there's 300 potential cases in Pittsburgh, it's hard to believe there are only 650 nationwide," said Schumer.

The senator went on to raise questions about BofA's decision to buy Countrywide.

"I've always wondered why Bank of America -- a fine institution with a good reputation -- was willing to purchase Countrywide, given its recent history, and I understand that there has been encouragement by the financial regulators to make this transaction happen," said Schumer. "These latest revelations should make Bank of America think even harder about how they want to proceed with the deal."

Dumb-o-meter score: 85. Something tells us that Countrywide officials will be headed back to Capitol Hill soon.

4. Sprint to the Finish

Sprint Nextel (S Quote) shareholders have suffered mightily since Sprint's ill-fated decision to pay $35 billion to buy Nextel in 2005.

The company has lost over half its value since the deal was consummated, and it has lost roughly 1.2 million subscribers amid outrageously bad customer service and a pathetic lack of integration between the two businesses. It recently wrote off most of the $35 billion investment in Nextel as an outright loss.

Luckily, The Wall Street Journal reports that Deutsche Telekom (DT Quote) may ask its shareholders to pony up for an equally bad deal and buy Sprint after Sprint sells Nextel to a consortium of investors organized by its co-founder, Morgan O'Brien.

Sprint Nextel shareholders would no doubt be delighted to wash their hands of this mess, but given their losses, they'll be sure to demand a hefty price tag in compensation. Meanwhile, Deutsche Telekom shareholders will be led down the primrose path by Wall Street bankers who stand to enjoy a windfall of fees as a result of the new combination.

Deutsche Telekom, which owns the fourth-largest U.S. wireless carrier, T-Mobile, will trumpet the deal as a chance to push into high-speed wireless market known as 4G and become the largest wireless carrier in the nation, with more than 74 million subscribers. That would put it ahead of AT&T (T Quote) and Verizon (VZ Quote).

Shareholders may want to consider how long it will take those subscribers to start jumping off the sinking ship they're about to pay for.

Dumb-o-meter score: 68. When in doubt, do a telecom deal.

5. Know When to Fold 'Em

Has Steve Ballmer called Jerry Yang's bluff?

The Microsoft (MSFT Quote) CEO walked away from the brink last weekend by refusing to pay Yahoo!'s (YHOO Quote) asking price to buy the Internet giant in a deal that would have resulted in a new rival for Google (GOOG Quote).

Microsoft raised its offer in last-ditch negotiations to $33 a share from $31, but then it balked after a foolhardy Yahoo! demanded $37. Jerry Yang, Yahoo!'s CEO and co-founder, now faces the wrath of shareholders at the company's annual meeting on July 3.

There are already rumblings of a shareholder revolt at the meeting, and Yahoo! shares -- after dropping 20% after the deal fell through -- have rebounded by 14% over the ensuing week as rumors swirled that a deal was still in the works.

For his part, Yang tried to dispel the popular notion that he wasn't open to a deal with Microsoft at any price.

"We as a company and I personally have always been open to a deal with Microsoft and I hope that in the the last few days it was clear that we have shown we're willing to do a deal with Microsoft but that we couldn't get to an agreement on price," Yang said.

But if Yang wanted to do a deal, he blew an opportunity to accept a good one when he refused Microsoft's higher offer.

"I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares," Ballmer wrote in a letter to Yang. "By failing to reach an agreement with us, you and your stockholders have left significant value on the table."

Ouch. Yahoo! passed up a 70% premium to its market price as of Jan. 31, the day before Microsoft unveiled its $44.6 billion bid. Yang walked away from a good deal, and Ballmer walked away from a bad deal. Who's left holding the bag?

Legg Mason Value Trust manager Bill Miller, a major Yahoo! stakeholder and a vocal supporter of Yang in the negotiations, recently revealed that his fund lost 20% in the first quarter on bad bets in the financial sector. Legg Mason (LM Quote) swung to a first-quarter loss of $256 million from a year-ago profit of $173 million.

Miller is hoping Ballmer will return to negotiations.

"If I'm sitting in their shoes, I'll go away and see what happens," Miller said of Microsoft. "I can come back, and the worst case is, I'll pay six months more of my free cash flow."

Dumb-o-meter score: 68. You never count your money when you're sitting at the table.