The Harder They Fall: The Last Days Of Bear Stearns Journalist Kate Kelly attracted international attention for her three-part series on the collapse of investment bank Bear Stearns. The story ran on the front pages of The Wall Street Journal in May 2008; now she's written a book on the subject.
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The Harder They Fall: The Last Days Of Bear Stearns

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The Harder They Fall: The Last Days Of Bear Stearns

The Harder They Fall: The Last Days Of Bear Stearns

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This is FRESH AIR. I'm Dave Davies, senior writer for the Philadelphia Daily News, filling in for Terry Gross.

In March of last year, Bear Stearns was the country's fifth largest investment bank, with $18 billion in assets. In a matter of days, the company suffered a financial implosion that left it broke and scrambling to survive.

The collapse of Bear Stearns, the first bank to crash as the nation's financial system unraveled, is chronicled in a new book by my guest, Kate Kelly, a reporter for the Wall Street Journal.

Her book describes frantic phone calls and intense meetings that took place over three days at Bear Stearns' Madison Avenue headquarters as the company faced oblivion. The crisis ended with the federal government negotiating the sale of Bear Stearns to J.P. Morgan for the shockingly low price of $2 a share. Three days before the shares had been trading at $57.

Kate Kelly has continued to cover the financial crisis, and last week she broke a story that led to the resignation of the chairman of the New York Federal Reserve Bank. Before joining the Wall Street Journal, she wrote for Time magazine and the New York Observer. Her new book is called "Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street."

Well, Kate Kelly, welcome to FRESH AIR. Tell us first a little bit about Bear Stearns. How is the culture of Bear Stearns different from other investment banks?

Ms. KATE KELLY (Wall Street Journal): Bear Stearns was a very sort of rough-and-tumble environment, and that's why I have chosen to call my book "Street Fighters," which is a term we used to describe the culture of the place in one of my stories at the Journal earlier on.

It was the smallest of the major investment banks, yet it was considered a major investment bank, in the same category as Goldman Sachs and Morgan Stanley and other names that may be slightly more familiar household names. But they had this culture of what was lovingly referred to as PSDs, people who were poor, smart and had a deep desire to be rich, and these people did not have to have a special pedigree. They did not to go to Ivy League schools. I think some of them didn't go to school at all, but they had a hard work ethic and a desire for success, and they were willing to come to this firm and do whatever it took.

I don't want to be mired in clichés, but another thing that was often said about Bear Stearns was that they were an eat-what-you-kill culture. So for example, if you were stock trader and you were able to nab a terrific client, even by kind of stealing that client from one of your colleagues, if the client wanted to go with you instead, God bless. You were on your road to a successful career with that person.

So it was a place where traditional rules did not always apply, and there was not an expectation of a certain cultural, social or educational background, and in many ways, especially earlier on in its history, it was very much of a meritocracy.

DAVIES: Now, the book focuses a lot on a four-day scramble in which the firm was struggling to survive. We meet a lot of interesting characters. One of them was the chairman, former CEO Jimmy Cayne, quite a character.

Ms. KELLY: He was quite a character. This guy was at the firm for most of his career. He was a very colorful person - swashbuckling, cigar-smoking, loved to tell salty stories. He actually was a little bit less of a PSD than some of the other senior people. He came from sort of middle-class origins outside of Chicago and had had a number of different gigs and lives, was driving a cab at one point in time, sold photocopiers at one point in time. I mean, he had a variety of odd jobs.

The firm did very well under him for a number of years. Their stock price exploded. Their return on equity, which is an important measure of Wall Street success, did incredibly well.

He was good at picking people who were talented from sort of lower ranks and building them up; however, in the end he became something of a liability.

In his last couple of years there, some of his habits, which involved leaving the office quite a bit, leaving the office early on a Thursday to go play a golf game and then being on the golf course for much of Friday during the summer, was one habit that came back to haunt him.

He played bridge competitively. So several times a year he would be out of pocket for a week to 10 days, playing on the bridge circuit, almost regardless of what was going on at the company. In fact, he was in Nashville, Tennessee playing in a tournament in July when they had their first major public setback, which was the failure of some hedge funds. This was July of '07. So he was absent.

The other thing was he had a proclivity, I am told by multiple sources, for using marijuana, and this is something that remained somewhat under wraps until I wrote about it in the Wall Street Journal in November of 2007, and while you might argue that it wasn't something he was doing at the office and it was not affecting sort of his decision-making from 9:00 to 5:00, it was something that he was doing in quasi-public settings, like at bridge tournaments while other people were present, in a men's room or at events at his home that involved some business people, some employees and things like that.

So it was something that sort of went to his image and people's perception of his quality of judgment. And when this came out, it was very troublesome people. I think even at Bear Stearns, which was something of a relaxed culture, they just thought, gee whiz, our company is on the ropes, and here's our CEO smoking pot. This is not good.

(Soundbite of laughter)

DAVIES: Right, right. Well, let's talk a little bit about why Bear Stearns got into such trouble. I mean, you know, looking back on it, all of these investment banks got into terrible messes, as did most large financial institutions. Why was Bear Stearns the first?

Ms. KELLY: I think Bear Stearns was the first because it was the smallest of a pack of about a half-dozen major investment banks and the least diversified, and what I mean by that is they did not have a mix of businesses such that they could sustain a major hit in one business and then offset it with gains or at least stability in other businesses.

They were overly dependent on bond trading, mortgages especially, and the way their financial structure was set up made them very vulnerable. Essentially they were very dependent on short-term financing, much of it renewed overnight, literally.

So if from a Thursday to a Friday their lender said, you know what, we think Bear Stearns is kind of weak, we're not sure they're going to be able to pay us back, we don't want to fund, that would pose a major problem for a Bear Stearns.

The other thing that happened to them is that they were a victim, I think, to somewhat hysterical reactions in the marketplace, and those reactions were based, on one hand, on a valid assessment of their business weaknesses, which I just mentioned, but on the other hand I think there was not a lot to the notion that they only had three days to live or four days to live.

However, once rumors got out into the marketplace that they were bleeding cash and that they might not be able to open their doors within a few days, it just fed upon itself, and their clients began taking out billions of dollars, literally. Their lenders got very gun shy and were also pulling back on billions of dollars, so that Bear Stearns went, in the course of four days, from having $18 billion on hand to less than three.

DAVIES: You know, I always find this so puzzling, that - and I've seen - we've read about this in other companies that have strong balance sheets that rely upon overnight financing, I mean to keep their operations running, and I'm always - I don't understand why they don't have a billion or so in cash so that they're not having to constantly renew these loans overnight.

Ms. KELLY: Sure. No, that's a very good point, and I do think that is starting to change, but it's a very slow process. For one thing, a billion dollars has a surprisingly short half-life on Wall Street. I mean, that could be gone with one worried client calling on the phone and demanding their money back.

Some firms have tried to set aside stockpiles of cash in order to combat this -Morgan Stanley, for example, and Goldman Sachs. The levels vary, but they both have $100 billion or more of cash, and things that are close enough to cash that we call them cash too, that they could draw on if they got into a situation like this.

So I think that's a more conservative approach that you do see at some places. But yes, Wall Street is remarkably dependent on the vicissitudes of the market, and you did have quite a widespread dependence on this overnight financing during this bull market, when borrowing was cheap and the business was solid, and there didn't seem any reason to mess with the system if it wasn't broken.

DAVIES: So Bear Stearns didn't have enough of a diversified business, but I think kind of what most people think when they look back upon this period was that the problem was everyone's reliance upon these mortgage-backed securities, where, you know, mortgage companies had been giving subprime mortgage loans to hundreds and hundreds of thousands of borrowers and that eventually the revenue streams upon which those securities were based, those mortgages were based, were going to collapse, because people would not be able to make the payments, and then the securities which had been fashioned from those mortgage payments would lose their value. Was that what happened to Bear Stearns? Were they too deeply into this subprime mortgage market?

Ms. KELLY: I think that's a great question and a complicated answer is what I have for you. I mean on the one hand, yes. I think optically speaking, Bear Stearns was overexposed to mortgages. They had a large mortgage portfolio. When J.P. Morgan and other suitors looked at them and thought about buying them as a company, they thought, Yee-gads, look at this mortgage portfolio, we're not sure we want to be stuck with this one, especially given that whatever the values are of things today, they're probably going to sink significantly in the coming weeks and months.

So I think that looked bad, and I think, yes, they did have a large mortgage business that was not going to be sustainable over the coming months and years.

That said, I do think Bear Stearns was a victim to a run on the bank, and I think the mortgage business looked like a point of vulnerability, but in real terms it was not sagging their business down at the time that Bear Stearns went under.

I think there was just a perception of weakness, a knowledge that they had the least amount of cash on hand and might have been the most reliant on overnight funding of all the major banks, and that therefore they were vulnerable and the market couldn't afford to have a shaky player like that continuing to lend, trade and do business with other, healthier firms. It was simply too risky.

DAVIES: You know, it's interesting because after the implosion of the company, the chairman of the Securities and Exchange Commission, Christopher Cox, said it was due more to a lack of confidence than a lack of capital. And if that's true, one would think that maybe an aggressive action by regulators to back up the company with credit the way the FDIC insures, you know, deposits of commercial banks to simply reassure traders and investors that they weren't lose their shirts, would the company have survived and would the entire course of this financial debacle have been different?

Ms. KELLY: I think the company would not have survived for any material length of time. There were a couple things that the government could have done. You're talking about, I think, FDIC-backed debt-raising exercises, for example, which companies are doing now, and I do think that's a helpful tool for companies. But for Bear Stearns to have raised two billion bucks or five billion bucks could've actually been petered away just as fast as their 18 billion was in that terrible week.

The other thought at the time was to open up the Fed's borrowing window, known as the discount window, to investment banks like Bear Stearns.

DAVIES: That's the Federal Reserve Bank, which has this discount rate borrowing to its member banks, right?

Ms. KELLY: That's right.

DAVIES: And they extended it to this investment bank, which was the first time that had ever happened, right?

Ms. KELLY: Well, it was unfortunate timing for Bear Stearns because at the time Bear Stearns went down, that borrowing tool from the Federal Reserve Board was not available to investment banks, only to commercial banks. On the eve of Bear's sale to J.P. Morgan, the Fed decided they would, in fact, open the discount window to investment banks, but it was too late for Bear.

Having said all that, I don't think either FDIC-guaranteed fundraising opportunities or the opening of the discount window to investment banks would have bought Bear Stearns very much time. There were so many disasters last year on Wall Street - the bankruptcy of Lehman Brothers, the scary period in September in which Goldman Sachs and Morgan Stanley saw their stock prices sinking, and Morgan Stanley saw clients pulling money out in droves, much as Bear Stearns had seen - that even, as you can see, some of the healthier banks who did have access to the discount window at that point in time were barely able to weather the storm.

So I still think at the end of the day, Bear Stearns was too small and sort of too flawed in its financing, its business model, to probably have lived much beyond 2008.

DAVIES: We're speaking with Kate Kelly. Her new book is "Street Fighters." We'll talk more after a break. This is FRESH AIR.

(Soundbite of music)

DAVIES: If you're just joining us, our guest is Kate Kelly. She is a reporter for the Wall Street Journal. She's written a new book about the collapse of Bear Stearns called "Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street."

You know, your book paints this very vivid picture of the last four days of the firm - I guess a Thursday through the Sunday in which, you know, investors and lenders were pulling out in a hurry. The company's stock was collapsing and they knew they needed to either get a government bailout or find a private company to buy it or declare bankruptcy.

So just give us a little bit of a sense of what that four days was like in their offices, which were actually up on Madison Avenue, right, not on Wall Street, right?

Ms. KELLY: That's right, 383 Madison Avenue, which is right near Grand Central Station. I think it was absolutely hair-raising inside of Bear Stearns during that 72-hour period. You had people working pretty much around the clock, having no idea what the future of their company or their own career would hold, wondering whether they would get bought by J.P. Morgan or some other suitor.

They had other people who were interested who were in and out of the building. They were also hearing from senior government officials, from the Federal Reserve Board, from the U.S. Treasury, from the Securities and Exchange Commission. Their funding situation, literally how much cash they had on hand, how much borrowing they could count on the next business day, was so much in flux that their treasurer spent days with staff members trying to put together like an Excel spreadsheet that would show them what their position was, and even then it was a guesstimate at best. So I think it was absolutely nail-biting.

DAVIES: So you had pizza boxes and cold coffee and empty wine bottles and regulators and potential buyers all sprawled through offices, trying to figure out a way out of this, and in the middle you had these government officials, whose names we know - I mean, Henry Paulson, the Treasury secretary, and Timothy Geithner, who was then, I guess, the president of the New York Federal Reserve Bank, and they had to confront the dilemma of what does the government do if the fifth-largest investment bank is about to go under.

Now, they could have done like a massive - the massive kind of assistance we saw later. Why didn't they? Talk about the dilemmas they confronted.

Ms. KELLY: Well, I think they actually did quite a lot at the time. The assistance that they offered was really very much unprecedented. They had a tough situation. They had both, I think, seen the schism happening between Bear Stearns and good health and had been concerned throughout the week, if not longer, about the firm's viability. And what happened initially on Thursday night was that Bear Stearns realized they were essentially out of cash.

I mean, they did not have enough money to open for business on Friday. So they made SOS calls to the government, to J.P. Morgan and others, and the Federal Reserve Board got together at 4:45 in the morning on a Friday and decided that they would essentially lend government money to Bear Stearns through J.P. Morgan, because remember at that time a company like Bear Stearns couldn't borrow directly from the government.

That in itself was unprecedented. They were dusting off bits of the Federal Reserve Act that had not been used since the 1930s, and here was Ben Bernanke, the new Fed chairman, who was faced with the biggest debacle since the Depression. He may not have realized it at the time, although the historic comparison that he was making in his head was to something from the Depression era in Europe.

So that in itself was a path-breaking move. Then through Friday they saw that the situation was deteriorating. The stock was essentially cut in half. The pull-out of cash on the part of clients and lenders continued apace. Investors were very worried, and it was clear that Bear Stearns would not last probably through Monday.

So Friday night, Tim Geithner, who's the head of the New York Fed bank, as you said, and Hank Paulson, the head of the Treasury, an experienced Wall Street person, got on the phone to the CEO of Bear Stearns and said, you know what, you have to sell the company by the end of this weekend.

Now, for him, Alan Schwarz, the CEO of Bear Stearns, this was kind of stunning. He was an investment banker who was experienced in deals, but a 48-hour period to sell one's own company under extreme duress was a pretty big challenge.

So what happened through the course of that weekend is the government monitored the situation. They saw how bad it looked, and on Sunday morning, when J.P. Morgan, who was prime to buy Bear Stearns and seemed like probably the best option to the government, anyway, for a variety of reasons - they were a bigger bank, stronger, they knew Bear Stearns very well because the two companies had had a longstanding relationship - J.P. Morgan said, look, we're uncomfortable with Bear Stearns, we haven't had enough time to do the proper research into their books, we don't know enough about their mortgage portfolio, we're just not sure we can take the risk of buying this company.

So once again the Fed had to step in, and in this case they offered to essentially agree to shoulder some of the down-side risk, if that mortgage portfolio were to sink in value. So they said to J.P. Morgan, hey, if you're willing to buy this company with about a $30 billion mortgage portfolio, we will assume the losses after the first billion dollars. We'll do that to help make this deal happen.

And again, I think it was a shocking moment for guys like Bernanke and Geithner. They had never seen anything like this. But they had a sense of what a calamity might be on their hands if they didn't step in.

DAVIES: I'm wondering what - you know, as you covered this, I mean, you spent a lot of time writing about financial stuff, and you're often writing for a readership of investors and economists and people who closely follow the business news - as this unfolded, did you have a sense that this could be a story that went way, way beyond people who normally follow business news, that this could, you know, could lead to the unraveling of the financial sector and with devastating impacts on the economy? Did you sense that happening as…

Ms. KELLY: I didn't know that Bear Stearns in itself would have that effect, but I did think that it might be the first domino to fall, and part of the reason I thought that is because the Fed seemed to think that.

They were very, very concerned when they met and decided on that initial Friday loan, and certainly when they agreed to guarantee the losses on the Sunday as part of the J.P. Morgan deal, about a small corner of the market called the Tri-Party Lending Market. And I won't get into too much detail about what that is except that it's a system in which banks and other financial institutions lend money to each other through the course of each business day, and it is trillions of dollars large, and because of the weakness of Bear Stearns and the concerns about the impact on Bear's lenders if they were to go bankrupt, it looked as though that entire mechanism was at risk. And if that mechanism were to fail, business could essentially grind to a halt in the financial markets, and that's what they were concerned about chiefly.

I know that Hank Paulson was thinking the Dow Jones Industrial Average might fall 1,000 to 2,000 points. I know that he and others were thinking if Bear Stearns goes bankrupt, Lehman Brothers is vulnerable, Merrill Lynch is vulnerable, Morgan Stanley is vulnerable, and of course as we saw he was absolutely right. But the events that showed those other firms' vulnerability unfolded over the course of six months rather than six days.

DAVIES: Kate Kelly's new book is called "Street Fighters: The Last 72 Hours of Bear Stearns, The Toughest Firm on Wall Street." She'll be back in the second half of the show. I'm Dave Davies, and this is FRESH AIR.

(Soundbite of music)

DAVIES: This is FRESH AIR. I'm Dave Davies filling in for Terry Gross.

We're back with Wall Street Journal reporter Kate Kelly, who chronicled the collapse last year of the investment bank Bear Stearns. It was the first of the banks to crash in the unraveling of the financial system. And Kelly's new book focuses on the company's frantic efforts in its final days to survive or find a buyer. Her book is called "Street Fighters."

So, Bear Stearns didn't go bankrupt. It was bought by this other investment bank J.P. Morgan for a very, very low price but with a fair amount of backing from the Fed on its mortgage-backed securities. And after the Fed had taken this extraordinary step of giving its access to lending. And you wrote a piece a year later, in March of this year, and you posed this question, was the decision to keep Bear Stearns from plunging into bankruptcy the right call or was it the original sin, you're referring to regulators, creating an expectation of U.S. government help that encouraged even more risk taking and delayed an inevitable reckoning and made the financial system even sicker?

I wonder how you address that question after this stretch of time. Did the government do the right thing?

Ms. KATE KELLY (Reporter, Wall Street Journal): I think in the end they did. I think in the end they did because the system was so interdependent and so vulnerable back in March of 2008. I think there was very little cognizance of what a rub we were in, of the interdependence of the lending mechanism in the financial markets which, of course, is the hub of investing for regular Americans and trading for many, many people around the globe. I think to let a company fail without setting up some sort of way to sort of blunt the impact and protect other firms at least temporarily, I think would've been very irresponsible.

DAVIES: You know, it's interesting, when I look at your job and when I look at what's happened in the financial industry over the last two years I sort of think of, this may be a reach, but Woodward and Bernstein, who were like essentially people covering police stuff, cops, reporters covering police stuff in Washington when these defendants come in having broken into the Watergate Hotel and suddenly discover they've got the story of the century because it involves, you know, a political crime which brought down the White House.

And you know you spend years covering all this financial stuff for a, you know, for a community of investors and business people and economists, and now it's like the story of the century. I mean, it's the unraveling of the financial sector and its effects on the economy at-large. And I'm wondering, as you and your editors and fellow reporters saw this unfold, did it change your sense of what you were doing, the mission, the audience that you wrote for?

Ms. KELLY: Absolutely. And one interesting anecdote I can tell you about that is that the week that Bear Stearns was struggling, it was mid-March of 2008, and we had been hearing rumors Monday, Tuesday, Wednesday about the troubles they were having, the notion that they were running low on cash. The company had made a couple of public announcements to try to counter those impressions, but nonetheless, the rumors persisted. And some of the gages that showed the market confidence or lack thereof in Bear Stearns, like a stock price or like an instrument that you can buy if you think a company's going to default on its debts, were indicating that there was quite a bit of fear there and it might turn into a real issue.

And I think it was Monday that I had prepared a story to run Monday night in Tuesday's paper about this and we decided to hold it. And our editors and I talked quite a bit about what to do. And I remember one of my bosses saying, look, we don't want to cry fire in a crowded theater. We don't want to become part of the problem. On the other hand, our job here is to cover the news and we can't irresponsibly make a problem worse. At the same time, we can't miss out on the biggest story arguably of the year.

So by the time the rumors persisted on Wednesday and it seemed unarguable that Bear Stearns was facing a problem, we ended up running a story, I think it was a "Heard on The Street" column that ran on Thursday, talking about Bear's issues with trading counterpart (bleep) and lenders and the sort of concerns that they were facing. But that was a perfect example of how you want to do your job and you want the public to know what's going on. On the other hand, you want to be responsible and not make something worse.

DAVIES: You don't want to generate a run on the bank in affect, right?

Ms. KELLY: Of course.

DAVIES: Right.

Ms. KELLY: Not.

(Soundbite of laughter)

DAVIES: Right.

(Soundbite of laughter)

DAVIES: Well, there's the other question I guess, of to what extent the financial press did the job it needed to do of sort of pointing out the underlying stresses and contradictions in the financial and regulatory structure. Do you have an opinion on that?

Ms. KELLY: I think it's a mixed bag. I think that in general the media could've been more prescient about what was about to happen. On the other hand, I do think there were articles talking about issues like leverage. And leverage, of course, is how much you borrow against the cash that you have on hand. And being over their heads in borrowing was something that really hurt a lot of the Wall Street firms. So I think, of course, we could've gotten ahead of this a little bit better. In the Journal's regard, I think that once this started to catch fire we were very aggressive about it and did not try to understate or overstate what was happening.

(Soundbite of laughter)

Ms. KELLY: But, you know, realize that Bear Stearns, for example, may have been the first domino to fall. And, in fact, going back the prior summer, Bear Stearns fell in March of '08, they had these two internal hedge funds that essentially blew up in 2007. And we broke that story and were chasing it the entire summer. And even though the hedge funds only had a combined 1.5 billion in management, which is not large in Wall Street terms, the way they fell apart due to leverage and due to the fact that they were exposed to risky mortgages seemed to us like a harbinger of things to come. And that was why we devoted so many column inches to it. And it was that situation that sort of primed my own interest in Jimmy Kane(ph) and led to my reporting in that fall about his sort of absentee leadership.

DAVIES: And I'm glad you mentioned the collapse of these two hedge funds that were owned by Bear Stearns. The Columbia Journalism Review is doing a piece for its upcoming issue about how well the financial press reported on the problems of the financial system before its collapse. And they have long list, I don't know if you've seen this, but a long list of stories that they think were of interest as the crisis unfolded. And one of those that they cited as an outstanding piece of investigative journalism was one that you wrote in June of 2007, which was about the collapse of these two hedge funds, these big, these investment funds that Bear Stearns had created. It was described by the Columbia Journalism Review as the official unveiling of the mortgage crisis, a huge, huge scoop. You want to talk a little bit about that story and its significance as you saw it?

Ms. KELLY: Sure. Absolutely. Essentially Bear Stearns had this asset management unit and they had hired, among other people, some former traders and salesmen from their bond department to start funds. And one of them had opened up a pair of hedge funds. One of them was a little less risky and the other a little more risky from the standpoint of the fact that it borrowed lots of money against its cash. So Bear Stearns had a manager who had started these two hedge funds and this guy had a very good record for a couple of years with solid returns, never had a loss. And suddenly, in the spring of 2007 things started turning around for him.

The performance of what was in his investment portfolio started to decline precipitously by double digit percentage points. And what happened as a result of that were two things. The folks who had given him money to invest, his clients, started asking for their money back. And the lenders who had given him funds to invest with that were borrowed started saying, we want some of our money back, or at least we want more cash down in exchange for what we're lending you.

So that started to happen and it became a real whirlwind. Over the course of a couple of months he went from being in great shape to being in miserable shape and not having enough cash on hand to meet either need. So Bear Stearns had to step in. And in the first week of June, my colleague, Serena Ng(ph) and I got wind of this and decided to keep an eye on it because it might be a good story. And at the time we were very focused on subprime mortgages. We saw that these two hedge funds were struggling and that they had a subprime connection.

And as soon as we heard that Bear Stearns senior leadership was thinking of bailing out these funds or had it on their radar screen, we thought that there's something going on here.

(Soundbite of laughter)

Ms. KELLY: So we jumped right into it and the whole thing unfolded very very quickly. I mean from early June, when we first heard about it, to July 31st, when the two funds filed for bankruptcy. It was under two months.

DAVIES: We're speaking with Kate Kelly. She's a reporter for the Wall Street Journal. She's written a new book about the collapse of Bear Stearns called "Street Fighters." We'll talk more after a break. This is FRESH AIR.

(soundbite of music)

DAVIES: If you're just joining us, we're speaking with Kate Kelly. She's a reporter for the Wall Street Journal. She's written a new book called "Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street." You recently broke a major story about the Chairman of the Federal Reserve Bank of New York, Stephen Friedman. What did you discover about his status?

Ms. KELLY: Stephen Friedman is a director of a large bank called Goldman Sachs Company. And he also owns stock in Goldman Sachs. The Fed has a code of rules governing folks like Friedman that say that you can't be a director, a senior jobholder, or a shareholder of a bank holding company, which is Goldman's technical classification. So when Goldman became a bank holding company, which happened sort of unexpectedly last September, he went from being perfectly in accordance with the rules to inadvertently being against the rules.

And the Fed, in order to keep him in his position at a time of turbulence, sought a waiver on those rules so that he could stay onboard. But it took several months for the waiver to be agreed upon. And during that period of time Friedman went out and bought additional Goldman shares. Now in fairness to Friedman, buying those shares didn't really affect the situation one way another. I mean essentially you're not allowed to have one or a hundred. So whether it was one or a hundred didn't really matter.

But I think it's a case of optics and the public being very uncomfortable with even the appearance of a conflict of interest. So here you had a guy who perhaps through no fault of his own was in violation of Fed rules and the Fed was working to rectify the situation and get him the waiver, but it hadn't come through yet. He then goes out and buys additional shares and I think it was just one of those things that kind of looked bad. And the reason that it may have looked bad is that the Fed now regulates Goldman. And, of course, Friedman is the Chairman of the Board of the regulator of Goldman. And even though he's not involved in day-to-day policy decisions, it just makes people uncomfortable thinking that there may be some coziness there between a guy who's got a vested interest in a company and the regulator that keeps an eye on that company.

DAVIES: Now is there any evidence that he used his authority in the Fed to help Goldman, his company?

Ms. KELLY: To be fair, there is not. And the Fed would argue that boards like the one Stephen Friedman chairs are not involved in policy decisions. They do not get pulled in on the eve of a Bear Stearns bailout and asked their opinion. They might be posted on the situation. Right after the fact they might take a look at how the Fed staff handled the situation after the fact. But they are not crisis managers and they're not in the loop on a hour-to-hour basis.

What they do do is select the head of the regional bank, which used to be Tim Geitner, and then, of course, Tim Geitner went to Washington to become the Treasury Secretary. So when that vacancy was opened Stephen Friedman was leading the search for a replacement. And the person that he came up with was William Dudley, an economist who had once worked at Goldman Sachs. So again, I think it's an optical issue.

I think that Friedman clearly has close ties to Goldman Sachs. Dudley is a Goldman Sachs guy. He's now running the Fed. The Fed has had a role in shaping regulatory policy during this crisis, and one could probably make a convincing argument that regulatory policy has benefited Goldman Sachs. Was Friedman in a room telling people you need to bailout Goldman Sachs? I don't think so. But this is a time of great sensitivity of public appearances.

DAVIES: Right. And we should note that Friedman has since resigned from the position really as the result of the controversy in your story.

Ms. KELLY: Mm-hmm.

DAVIES: But you know part of my reaction when I read this was that it seems to me that the world of Wall Street and government regulators are so accustomed to revolving doors, one moving into another, that this relationship didn't strike me as so odd. I mean, bankers themselves - they actually appoint the members of the Federal Reserve banks, including the three who are supposed to represent the public. Is this really so unusual? I mean aren't these kind of conflicts almost endemic to the system?

Ms. KELLY: They are endemic to the system and I think the Federal Reserve System was set up very intentionally as an organism that would be composed of members of the banking community, that would be owned by the banking community, and would also regulate the banking community. So that was very much by design and I think they tried to set up some ways in which conflicts of interest could be mitigated, such as having boards that advised, but not on a sort of crisis-to-crisis basis, more on a sort of blue sky, philosophical basis.

The question now is does this still work? Does the Fed need more public scrutiny, should the banking community be as embedded as they are in these essentially regulatory structures? And I think that's what members of Congress and even former Fed officials are now taking issue with. I don't think the Freedman story would have been very much of a story five years ago. Of course it would have been moved because you wouldn't have seen Goldman Sachs became a bank holding company. But, you know, what I'm saying. I don't think the public outrage would have been there.

DAVIES: Do you think that this is one of those cases where people are so accustomed to a certain way of doing things. Like people who are used to getting big bonuses that they don't even think about, you know, a 15 or 20 million dollars bonus. That people who have spent their lives in investment banking in the Fed system would think nothing of holding these two positions which would seem to pose a conflict.

Ms. KELLY: I think it may be a case like that, yes. And in fact, the Wall Street Journal editorial page wrote about this and I think they make a fair point, which is: this is a wealthy man, I don't think he was necessarily doing this because he was greedy. I think he saw a good investing opportunity by his own admission. He said the stock seemed cheap at the time and it absolutely was. He bought it at about $65 and then again at about $80. The stock is now well north of a $100. So he was right on the merits of it. And I think - I think you're correct to say when you spend many years in a system and this gentleman is 71 and he is very experienced, you just may not necessarily realize that the times are changing and things that may have been acceptable five years ago or even three years ago are now not passing the smell test. I think that can happen to people.

DAVIES: We're just about out of time but, Kate Kelly, I wonder, you know, if you could just give us your perspective on how worried we should be. I mean, you know, the government just completed the stress test of the large banks and seemed to be saying they're okay as long as they raise some more capital. What's your sense of the fragility of the financial system these days?

Ms. KELLY: You know, I think we should be concerned. If you look at some of the recent economic data, last Friday unemployment numbers were announced and unemployment is now at 8.9 percent. And the feeling is that the pace of joblessness is slowing but even the Obama administration predicts that we could see unemployment of close to 10 percent and no recovery until the end of next year. As I mentioned credit card debt is an increasing issue and the average American household has almost $10,000 of credit card debt, and in many cases not much sense of how they're going to pay that back.

The stress tests, I have to say, were the subject - they were the butt of the joke in the opening sketch of Saturday Night Live on Saturday night.

(Soundbite of laughter)

Ms. KELLY: And to me that was a real cultural barometer. They essentially had a guy playing Tim Geithner talking about what a joke the stress tests were. Now this may be unfair. The government has said that a number of institutions need to raise quite a bit of capital, and that's a clear signal to everybody that they are not in perfect health. But it's hard to say that there won't be another leg down, and it's hard to say that the banks are on unsafe territory.

I think a number of the banks would like to repay the government's investment in them, under the Troubled Asset Relief Program, which dispersed money last fall to the major banks, nine of them. And yet the government hasn't agreed to anybody to do that yet, because I think the Fed and others are concerned that they may not have seen the worst of it yet. So it's a difficult time - it's a difficult time. And I think unemployment scares a lot of people and rightly so because if you don't have a job to try to pay the bills how are you going to get out of this mess. How are you going to pay off your debts or deal with education and healthcare costs? Let alone housing costs, which were part and parcel of this crisis.

DAVIES: Kate Kelly thanks so much for speaking with us.

Ms. KELLY: Thank you. I enjoyed it.

DAVIES: Kate Kelly is a reporter for The Wall Street Journal. Her new book about the collapse of the investment bank Bears Stearns is called "Street Fighters."

Coming up, Ken Tucker on the debut album by Tinted Windows. This is FRESH AIR.

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