Bear Naked Tradies

Who put together the AOL Time Warner merger. They went with Bear, Alan Schwartz—you can bet he pulle
d in eight figures on that deal.

Being the best on the trading side was a little trickier. Bear didn’t have a lot of liquid, so to make the big bets that would feed the Bear, everything had to be leveraged to the gills. If your bet was right, your bonus would be lovely. In the climate of hedge funders making risky bets and priapic bonuses, the Bear culture—the cafeteria that got health-code violations—it was only natural that this man, the Bear man, would take things a step further. A smart hardworking rebel, but on shakier ground. Working harder wouldn’t cut it. This Bear man had to be scrappy in a different way. Trading is about risk. The new Bear beast had to risk more to be a star, to make big bets, bets his ass couldn’t cash. How do you do that? Get creative.

Enter Ralph Cioffi (pronounced Cho-fi). A Bear man through and through. Born in South Burlington, Vt. Running back at Rice Memorial High, St. Michael’s College in Colchester, studied business and bodybuilding, too. Flagged for star status under the aegis of his mentor, Warren Spector, he was put in charge of the structured credit sales and production unit.

Like everyone else, he was looking to take advantage of the housing boom, but do it better, riskier, more profitable—the new Bear man. So he creates a new type of collateralized debt obligation, CDOs, which are mortgage bonds that are sliced and diced into bundles with differing default risks. They’re called Klio Funding, and they were catnip to the $2 trillion mother lode of money-market accounts. And mortgage bonds have the highest ratings, so they could be leveraged up the wazoo. In some cases, banks like CitiGroup and Barclays were giving out loans of 20 bucks to 1. And why not, the housing market is booming, prices are going up. If a guy defaults on his loan, well, he or the bank can sell the house at a profit. The more mortgage bonds Bear buys, the more fees banks make, and the more likely they are to want to make more loans to make more fees.

A guy who worked with him said the thing about Mr. Cioffi, which is symptomatic of the Bear culture, is that he was promoted from a salesman position to a money manager position. “I have no idea why he was put in that position,” said the colleague. “He had no experience. He’d been very successful in sales. But those are two totally different jobs.

“So what does he do in this new position? He sells, sells, sells his fund on investors, and then leverages the investments, basically raising money very successfully.”

Other investment banks began to buy these bonds. Bear the scrappy pit bull had the white shoes tap-dancing to its tune. Man, that must have felt good.

Mr. Cioffi proposed that Bear create in-house hedge funds with a similr strategy. And so they did. He raised $1.6 billion for his two mortgage-bond-related hedge funds.

He bought that mansion in New Jersey and a place in Florida, too.

Then the ass fell out of the housing market. People couldn’t afford their mortgage payments, the ratings of the bonds went down. Investors tried to get out while they could, but the raging pit bull had a problem. The trick about mortgage bonds is that you have to be able to sell them, and when they’re leveraged 20 times over, the price can only fall so much before you lose money. So they lost everyone’s money. Everyone’s.

“He was probably a believer, drinking the Kool-Aid, and thought this was a minor blip,” said another former Bear associate who’d done his time and now works at a hedge fund.

No siree. Mr. Cioffi was no dummy. He had created the Kool-Aid. The Kool-Aid had made him a star. And once the mortgage market started to sour, he was stuck.

The new Bear man, embodied by Ralph Cioffi, has lost his way. He has all but forgotten the principles the firm was founded on; he’s has been infected and emasculated by the era of runaway greed and giant paydays that the growing bunch of brazen hedge funders and private-equity boys flash about. He is still steeped in that Bear culture: be the star, do it yourself, beat the other guys, make the big kill. But he has no right to be gambling, lest he lose his shareholders’ money and disparage the bank’s reputation.

In March 2007, Mr. Cioffi told a colleague, “I’m sick to my stomach over our performance in March.” And he wasn’t kidding. And because he was a Bear man, he felt more than a little sick. How sick? Bear sick.

smorgan@observer.com