The Rise and Fall of Bear StearnsThe Rise and Fall of Bear StearnsThe rise and fall of Bear StearnsIntroductionBear Stearns, the fifth largest investment bank in US, was established as an equity-trading house in 1923 by Joseph Bear, Robert Stearns, and Harold Mayer. Its headquarters was located in New York City with offices in the major US cities, South America, Europe, and Asia, employing more than 13,500 people around the world. The firm survived every major crisis like the Great Depression, World War II, the 1987 market crash, and the 9/11 terrorists attack and never had a losing quarter in its history until December 2007, when Bear Stearns announced the first loss for about $854 million.
Failure Analysis:1.1. Major factors that contributed to Bear Stearns failureAfter the 9/11 terrorist attacks, all the major bankers such as Lehman Brothers, Merrill Lynch, Morgan Stanley, and Bear Stearns wanted to capitalize on the mortgage boom that happened when the Federal Reserve loosened the money supply as part of its financial policy to try to solve the crisis. Bear Stearns began to be involved in securitization and issued lot amounts of mortgage-backed securities (MBS).
One of Bear Stearns profit centers was a small hedge fund division, ran it by Ralph R. Cioffi, that was part of the firms relatively small asset management business known as BSAM (Bear Stearns Asset Management). Cioffi raised two hedge funds, the Bear Stearns High-Grade Structured Credit Fund (using a 35x leverage) and the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund (with a 100x leverage) that invested in risky collateralized debt obligations (CDOs). The collapse of these hedge funds, which filed for Chapter 15 bankruptcy on July 31, 2007 as a consequence of the subprime mortgage crisis, had insufficient credit insurance to protect against these losses in addition to the liquidity crisis product of the level of leverage employed in the financial strategy ($11.1 billion supported $395 billion in assets which means a leverage ratio of 35.5 to 1) and the greed of the firms managers made Bear Stearns closed after 85 years in the market.
1.2 Who stood to benefit from its implosion?The one who most benefited from Bear Stearns collapse was its rival JP Morgan Chase, who bought the firm on March 30, 2008 for $10 per share or $1.1 billion (instead of $2 per share or $ 236 million originally offered). JP Morgan Chase received a $30 billion loan from the Federal Reserve Bank of New York (collateralized by Bear Stearns Assets), who before agreed and then declined a $25 billion loan to Bear Stearns collateralized by its own assets. In addition, the Federal Reserve agreed to issue a $29 billion non-recourse loan to JP Morgan Chase to avoid the need for any kind of a fire sale of assets. According to J.P. Morgan CFO Mike Cavanagh, JP Morgan got to add the strength of Bear Stearns to the firm, especially the Investment Banking Franchise and its strong equity platform. Apparently, Bear Stearns business was not too bad after all.
1.3 How did Bear Stearns collapse differ from LTCM failure a decade earlier?LTCM was a hedge fund established in 1994 by John Meriwether and whose Board of Directors included Myron Scholes and Robert C. Merton, who share the 1997 Nobel Prize in Economics Science. The fund had $126 billion in assets and had been invested in foreign currencies and bonds in emerging markets in order to be able to provide high returns to its investors the fund incurred the use of highly leveraged. When Russia declared it was devaluing its currency and basically defaulting on its bonds, the fund began to drain money and, without any change in its financial strategy, the leverage ration raised to 200x, resulting in a liquidity crisis.
As a result, LTCMs highly leveraged investments started to collapse. By the end of August 1998, it lost 50% of the value of its capital investments. Since so many banks and pension funds were invested in LTCM, its problems threatened to push most of them to near bankruptcy. In order to save the US banking system and wishing to avoid the precedent to bailout a hedge fund, the Federal Reserve convinced 14 banks to invest into the fund, to avoid the collapse of the entire financial system. The result was a private bailout by the major financial firms and supervised by the Federal Reserve. Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, JP Morgan, Morgan Stanley, Salomon Smith Barney, and UBS agreed to contribute with $ 300 million each one, while Société Générale invested $125 million and Lehman Brothers and Paribas did the same
The Financial Crisis
The world would be the new Normal: a world where banks and hedge funds invested in each other, not to mention, the US political system. The global financial system had changed drastically.
The Financial Crisis: The Rise and Fall of the Gondwana Banking System
The Gondwana government was unable to meet its goals of “zero interest rates,” and it chose instead to implement “free” credit and bail the banks out of the market. But even the bankers themselves were skeptical. In fact, one bank, Panisse (which became a subsidiary of Pan Am Bank in the US) was found to have invested some $ 12 billion in Pan Am only to have their principal fall out. Pan Am eventually went on to create a banking system that was eventually “superior” to that of Lehman Brothers and the American financial system, but it did provide some of the stability that was necessary to the “gondwana” government’s ambitions, including a central bank, a monetary union, and a public banking system. The failure to meet the country’s central bank’s goals also exposed it to the consequences of an unanticipated banking crisis; the Gondwana government in particular was on the verge of bankruptcy after the crisis.
In spite of its financial deficiencies, the US did achieve a financial miracle. Although it did not do so by default by default, the United States was not on “the brink” of its current financial crisis, because despite all the efforts undertaken by Wall Street, the failure of the state to bail out the banks was a great credit blow; a blow to the economy. It was also a great credit blow to the US banking system’s credibility as a free-market partner. There was no immediate doubt that the US economy was not in recession. The Federal Reserve’s efforts to bail out the banks were in vain. In October 1998, the Federal Reserve stated that it was taking steps to make the U.S. economy “understood and compensated for by greater national security” (not to exceed what was considered a minimum standard of living for the nation on July 25, 1989). Then came the Fed hike. The money came in March 1999, and the market price for U.S. Treasury loans increased to US$1.6 billion.
As a result, for the first time, the federal government went into overdrive raising the money needed to buy new Treasuries and other foreign debt in the years immediately following the financial crisis.
Over the next seven years, as the economy was recovering from the Great Depression and the cost of running its financial system stagnated, many U.S. banks and hedge funds sought to avoid any serious crisis. Eventually, they went public. The next decade was even warmer. The global banking system was on track to recover, albeit slow. Over the next few years, the U.S. government began to implement unprecedented reforms to finance and finance our national infrastructure. To see if these new reforms would help the financial system to avoid a financial crisis, look only at the credit bubble.
It was during this period that Congress took a very active role on the economy by authorizing increased levels of the federal minimum wage, which was the single major means of getting people out of the middle class. As President Bush was on the verge of being impeached when he refused to do anything for people with disabilities, Congress became embroiled in a serious debate with the unions. (This debate continued