In search of Bear's market: The investment banking industry has seen better days. But CEO James Cayne intends to prove that when the going gets tough, Bear Stearns digs in.

Jimmy Cayne's view from his corner office at Bear Stearns' new, high-tech Madison Avenue headquarters isn't as fabulous as his old one on Park Avenue. But no matter. The investment firm's chairman and CEO isn't going to be spending much time gazing out the window.

Not that Cayne, a self-professed workaholic who lives 10 minutes from his office, ever did much of that. But New Year's 2002 marked the close of one particularly depressing year for the investment banking and brokerage industries. And Bear Stearns' tough-talking leader is now charged with making sure the firm, one of Wall Street's few remaining independent players, keeps pace with its larger rivals.

That means not only sustaining Bear Stearns through the industry's crisis period, but strengthening its structure to ease the eventual transition to Cayne's successors. While the 67-year-old hasn't announced plans for retirement yet, last June's promotion of Alan Schwartz and Warren Spector to a shared No. 2 spot has prompted speculation that Cayne's countdown has already begun.

Bear Stearns' chief is in good company; nearly every Wall Street firm has taken one hard to the gut. The dot-com bust and the recession dried up the IPO market and related underwriting business. Mergers and acquisitions slowed to a standstill in 2001, and retail brokerage volumes plummeted as panicked investors fled the markets.

Then came September 11--the unforgettable event that exposed the industry's vulnerability and displaced thousands of financial district workers. It also inspired an atmosphere of cooperation and goodwill among competitors that was anomalous to veterans like Cayne. "I've never seen all these people, the heads of every major firm, sit in a room and not hate each other," he says of the unprecedented September 13 meeting to discuss the reopening of the New York Stock Exchange following the attacks.

Things had already taken a grim turn on Wall Street by the time the twin towers vanished from the skyline. In the months following the attacks, firm after firm, including Merrill Lynch, Morgan Stanley Dean Witter, and Goldman Sachs, announced huge layoffs, making 2001 the year of the most job losses in the brokerage industry since 1987, according to the Securities Industry Association.

Bear Stearns reluctantly joined the ranks in October. Although its fixed income was performing well--net revenues jumped 78 percent in third quarter 2001 from the same quarter in 2000--other areas suffered. Its investment banking business in particular sagged under the weight of heavy bets on disappointing sectors, such as telecom, according to Ken Worthington, equity analyst for CIBC World Markets. And 2001 market volatility made Bear Stearns' one-year stock price graph look like an EKG readout.

So as part of a margin improvement program designed to cut costs by $250 million, Bear Stearns trimmed its workforce by about 7.5 percent, firing some 800 employees, the largest layoff in its 78-year history. "That's what you get to when you recognize that you're part of an industry that's high power and successful, but at the same time, overcapacitated to a fare-thee-well," says Cayne. "It's painful, but you have to do it."

As another cost-cutting effort, and to show solidarity with remaining employees, the five members of the executive committee opted to forfeit 50 percent of their 2001 bonuses. This amounted to a 70 percent reduction year-over-year in compensation, the company estimates.

Those are both good starts, says Worthington. "I want to see those costs fall to the bottom line. They've been ramping up Europe so a lot of the cost-savings they've done heretofore was spent in other areas." With most of that spending completed, particularly on expansion in London, the firm should be able to leverage its cost-cutting, he adds.

Also, while Bear Steams doesn't have major plans to expand into new territories or bring new products to market, it has been successfully leveraging customer relationships in its disparate businesses to cross-sell products. Add in a healthy fixed income business and one of the largest clearing businesses around and some analysts say Bear just might be able to hibernate for the winter recession. Though all investment banks' numbers were down for third quarter 2001, Bear Stearns was one of the few that outperformed analysts' expectations.

That said, the fortunes of companies like Bear Stearns are made through savvy risk-taking. And while experts agree the post-September 11 climate and prolonged military conflict aren't likely to have a direct impact on Bear's business, the events have made its CEO far more tentative. "I'm less likely to commit to something that would be a 60-percent-yes, 40-percent-no situation," Cayne says.

That's a shift from the exciting adventure in the municipal bond market that put Cayne on the map in the l970s. It was during New York City's fiscal crisis that other investment banks, fearing defaults, were dumping the city's debt securities like crazy. But the numbers convinced Cayne that a general default was not likely. "I saw a big vacuum there, I saw Bear Stearns had some money, and I had a good way to sell these bonds," he recalls. His idea was met with slightly less enthusiasm at the firm than he'd hoped. "I got shot down all the way up to the senior partner." But the powers gave their reluctant blessing, and the risk paid off big--for both Bear Stearns and Cayne, who earned respect and, eventually, a ticket to the top of the ranks.

But the uncertainty ahead has dampened the adventurous spirits of more than a few CEOs. While Cayne says he'd gladly take other calculated risks--"if I saw an excellent chance of winning and a very small chance of losing, absolutely"--for the most part, he's playing it safe. And that begs the question: How can CEOs keep operating costs down while simultaneously building up the more profitable businesses and increasing innovation to stay competitive?

"That's the balancing act that separates the men from the boys," says Cayne, a member of the Old Boy's network since 1969, when he joined Bear Stearns as a broker after six years as scrap iron salesman and a brief stint as a professional bridge player. He was interviewed for the job by Alan "Ace" Greenberg, Bear Stearns' larger-than-life former chief, and it was the start of a close working--and bridge-playing--relationship that would span more than three decades.

"He's still my No. 1 consultant," Cayne says. He doesn't have to go very far to find Greenberg, who gave Cayne the chairman spot in June 2001 (after ceding the CEO title in 1993). But as chairman of the executive committee with an office on Bear's trading floor, Greenberg is hardly out of the picture. And Cayne, even after years of media criticism that he's operating in the shadow of his former boss--and that it will be far more challenging to carve out his own unique stamp with Greenberg around -- is clearly not concerned about sharing some of the spotlight. "Alan Greenberg's responsibilities and what he does are virtually unchanged since 1985 when we first became a public company," says Cayne. "He does his thing and I do my thing and the two synergistically have worked out pretty well."

Greenberg, for his part, plays down his role, though he's clearly plugged into the goings-on at the firm. "I'm still working. I still get paid. But there's no question who's the chairman of the board," he says.

The advantages of Greenberg's continued close involvement are apparent even to those who generally think outgoing CEOs ought to ride quietly off into the sunset. It depends on what's in the best interest of the shareholders, says Peter Crist, vice chairman of Korn/Ferry International. "The securities industry is a relationship industry, and Ace probably knows more people than half the human beings in the financial community," says Crist. Greenberg's value to the firm, "even as chairman emeritus," is worth having him hang around, says Crist, adding that such an arrangement requires a considerable sacrifice of ego on the part of the sitting CEO. "It takes a very special person.

The surprisingly self-effacing Cayne would likely shrug off such compliments. And he speaks his mind candidly even after being chewed out for media gaffes. The June 2000 incident, in which Cayne reportedly told Salomon Smith Barney Analyst Guy Mozkowski that the firm was for sale at four times book value, or approximately $120 a share, is still talked about today. "That was all nonsense, Cayne says, sucking hard on a signature cigar. "There isn't anybody I talked to who had an interest in hooking up with Bear Stearns who really looked at that as a serious comment. And I wouldn't negotiate with anyone who did."

Which doesn't mean the firm isn't friendly to the right offer, he's quick to add. But the last nibble that made headlines was back in November 2000, when Lehman Brothers was rumored to be courting. Since then, industry observers have increasingly wondered whether Bear Stearns would be able to survive as a bachelor, particularly as many of its competitors have married into huge conglomerates.

"[Bear Stearns] is a marvelous competitor," says Brad Hintz, securities industry equity analyst with Sanford Bernstein. "The question is, with a smaller investment banking operation, smaller trading business, and a consolidating industry, how much longer can this strategy work?"

Cayne looks to history for the answer. "Since I've been around, 95 percent of the people who've competed with this company are no longer competing with this company. That's an unusual statistic." He proudly cites Bear Stearns' culture, its relatively low rate of attrition, its no-nepotism policy (if two employees decide to marry, one has to resign), and an anti-hierarchical environment.

"Jimmy's style of management is very collaborative," offers Alan Schwartz, co-president and co-COO. "I can walk into his office and say, 'I really disagree with the way we're going and we need to talk,' and there is zero chance we won't have that conversation."

Senior officer involvement should help the firm during an eventual transition to new leadership, although Cayne insists he never thinks about succession. "I might get a slip in the mail one day that says 'Jimmy, it's over,' "he jokes.

But the increased volatility isn't going to scare him off. "That's the beauty of this thing," Cayne says calmly through a hazy cloud of cigar smoke. "Nobody ever knows what's going to happen."

The Difference a Year Makes

BEAR STEARNS' NET REVENUE IN MILLIONS $

                   Q3 2001  Q3 2000

Capital Markets
Institutional       $244.7   $358.0
 Equities
Fixed Income        $416.1   $233.3
Investment          $213.5   $220.4
 Banking

Global Clearing     $192.0   $241.7
 Services
Wealth Management   $128.0   $160.1

Source: Company reports

Note: Table made from bar graph