The Big Fall: Bear Stearns

The subprime mortgage crisis is known for the spectacular collapse of some of the largest financial institutions in almost no time. Bear Stearns is a prime example of this. This was an institution that was built on decades of hard work and innovation.

However, certain risky bets made in the markets led to the famous collapse of Bear Stearns. Post the collapse Bear Stearns was taken over by JP Morgan Chase. In this article we will discuss about the collapse of Bear Stearns as well as its acquisition in detail.

History

Bear Stearns was one of the largest investment banks in the world based out of New York city. This bank had developed a reputation as being a risk taker. The traders at Bear Stearns were known to take risky positions whenever they saw an opportunity for profit.

In the past, all these trades had paid off and Bear Stearns had ended up becoming a successful and admired corporation. The Fortune magazine ranked Bear Stearns as being one of the most innovative companies in the financial sector.

Bear Stearns continued this innovative streak when they decided to enter the US subprime mortgage market. The market was relatively new and complex which caused many companies to take a defensive stance. However, that was not the case at Bear Stearns.

Subprime Mortgage

Bear Stearns was amongst the first banks to be hit by the subprime mortgage catastrophe. Two hedge funds operated by Bear Stearns were working exclusively towards investing money in the secondary subprime mortgage markets. These two funds were the first to collapse.

In fact, their collapse was what changed the mood of the markets from skeptical to fearful and created a massive selloff which was responsible for and further aggravated by the fall of Lehman Brothers.

Lehman, however, defended the fall of the two hedge funds as being isolated incidents which did not depict the true story of the firm’s finances. A large scale public relations campaign was put into place.

The CEO of Bear Stearns repeatedly ensured investors that their money was indeed safe at the bank. Also, letters were sent out to many of the bank’s customers ensuring them of the soundness of the bank’s financial position. Lastly, a stake was given out to billionaire Robert Lewis to raise the investor confidence regarding the bank’s finances.

Gold and Silver

Besides being on the wrong side of the trade in the secondary mortgage market, Bear Stearns also found itself on the wring sides of the trades in the commodities market. Bear Stearns was heavily invested in the gold and silver market. In fact, most of Bear Stearns investments in these commodities were via the derivatives route i.e. these investments were highly leveraged.

To add to this, gold and silver prices rallied during this period. Gold prices went up by 25% in a matter of months whereas silver prices went up 33% during the same duration. Bear Stearns was the biggest investment bank that had gone short on gold and silver during the same time frame. This means that Bear Stearns had borrowed a lot of money and bet it on the possibility that the prices of gold and silver will fall. However, the opposite happened.

In fact, the day of the fall of Bear Stearns also coincides with the day on which gold and silver prices rose historically. It is said that Bear Stearns faced a $2.5 billion margin call in the same day. However, already cash strapped and levered over 35 times, Bear Stearns could not fulfill this margin call leading to the fall of this behemoth.

The Fall

The public relations campaign by Bear Stearns management did not seem to work. The bank collapsed in almost no time. Within a matter of weeks, Bear Stearns went from being a world class investment bank to being bankrupt. Bear Stearns faces a classic run on the bank as more and more customers came in to withdraw their money. The bank was running out of cash at an alarming rate.

However, this situation was never known to the customers. As far as the customers are concerned, they did not lose even a single cent in the process. However, behind closed doors Bear Stearns was reeling. Bear Stearns had received a special credit facility from the Fed which they were using to payback their customers. However, this was a temporary arrangement. A few weeks later Bear Stearns was sold off to rival bank JP Morgan Chase.

The Acquisition by JP Morgan Chase

The Bear Stearns acquisition by JP Morgan Chase faced a lot of scrutiny from the media and the general population. Bear Stearns had been trading at $93 per share months before its demise. Then, all of a sudden it was sold to JP Morgan Chase for $2 per share. A lot of investors felt that the price offered was a pittance and as a result JP Morgan faced a class action lawsuit. After the lawsuit, the prices of the shares were posthumously raised to $10 per share. However there was still a lot of controversy surrounding this sudden and unannounced takeover of an erstwhile financial giant.