Bear Stearns

Based on Wikipedia: Bear Stearns

The Five-Day Death of an 85-Year-Old Bank

In early March 2008, Bear Stearns had eighteen billion dollars in cash. Five days later, it had two billion. Within a week, an investment bank that had survived the Great Depression would be sold for the price of its office building.

This is the story of how eighty-five years of Wall Street history evaporated in less time than it takes to get a passport renewed.

From Three Founders to Global Giant

Bear Stearns came into the world on May 1, 1923, when three men pooled five hundred thousand dollars to start an equity trading house. Joseph Ainslie Bear, Robert Stearns, and Harold Mayer had big ambitions but rocky relationships. Internal tensions among the founders reportedly escalated to the point of at least one public scuffle—not the last time tempers would flare at the firm.

Yet somehow, the partnership worked. When the stock market crashed in 1929, triggering the worst financial crisis in American history up to that point, Bear Stearns didn't lay off a single employee. By 1933, while banks across the country were failing by the thousands, the firm was expanding—opening its first branch office in Chicago.

The company grew steadily through the mid-twentieth century, opening an international office in Amsterdam in 1955. In 1985, Bear Stearns went public, selling shares on the stock exchange and transforming from a private partnership into a publicly traded corporation answerable to outside shareholders.

By 2007, Bear Stearns had become one of the titans of Wall Street. The firm employed more than fifteen thousand five hundred people across the globe. Its headquarters occupied a prestigious address at 383 Madison Avenue in Manhattan, between East 46th and East 47th Streets. The company had offices scattered across American cities from Atlanta to San Francisco, and international outposts in financial centers including London, Hong Kong, Tokyo, and São Paulo.

Fortune magazine named Bear Stearns the "Most Admired" securities firm in America in both 2005 and 2007. The annual survey ranked companies on employee talent, risk management quality, and business innovation. By any conventional measure, the firm was at the peak of its powers.

The Mortgage Machine

To understand what killed Bear Stearns, you need to understand what a mortgage-backed security is—and why it seemed like such a brilliant idea at the time.

Here's the basic concept. A bank makes a thousand home loans. Each loan is risky on its own—any individual homeowner might lose their job and stop paying. But if you bundle all thousand loans together into a single financial product, the risk gets spread out. Maybe five percent of homeowners default in a bad year. That means ninety-five percent keep paying. The bundle as a whole remains profitable.

A man named Lewis Ranieri, often called "the father of mortgage securities," pioneered this technique. Wall Street firms like Bear Stearns took it and ran with it. They packaged mortgages into securities. They sliced those securities into different risk levels called tranches. They sold the pieces to investors around the world.

The machine hummed along beautifully for years. Banks made more loans because they could sell them off. Investors earned steady returns. Home prices kept rising. Everyone made money.

Then the music stopped.

When the Numbers Stopped Making Sense

By late 2007, Bear Stearns had accumulated a balance sheet that would have made a more cautious banker faint.

The firm held approximately $13.4 trillion in derivative contracts. To put that number in perspective, the entire economic output of the United States that year was about $14 trillion. Bear Stearns, a single company with fifteen thousand employees, had derivative exposures roughly equal to the gross domestic product of the world's largest economy.

Even more concerning was something called "Level 3 assets." These are financial instruments so obscure that there's no market price for them—the company holding them essentially gets to decide what they're worth. Bear Stearns had $28 billion of these assets on its books. Against this, the firm had only $11.1 billion in equity—the actual money belonging to shareholders.

The ratio between assets and equity tells you how leveraged a firm is. Bear Stearns was leveraged 35.6 to one. For every dollar of actual capital, the firm had almost thirty-six dollars of assets. This is like buying a $360,000 house with a $10,000 down payment. If the house drops in value by just three percent, your entire investment is wiped out.

And the assets Bear Stearns held were dropping in value by a lot more than three percent.

The Hedge Funds Go First

The crack in the dam appeared on June 22, 2007, when Bear Stearns had to pledge $3.2 billion to bail out one of its own hedge funds.

The fund had a typically opaque Wall Street name: the Bear Stearns High-Grade Structured Credit Fund. Despite the reassuring word "high-grade" in the title, the fund was stuffed with collateralized debt obligations, or CDOs—complex securities built from bundles of mortgages and other loans.

These CDOs had a problem. They were "thinly traded," meaning almost no one wanted to buy them. When Merrill Lynch seized $850 million worth of CDOs as collateral from a Bear Stearns fund, it tried to auction them off. The bank could only sell $100 million worth. The rest had no buyers at any price.

Think about what that means. Assets supposedly worth $850 million turned out to have a market value of roughly twelve cents on the dollar. And Bear Stearns was loaded with similar assets.

By mid-July, Bear Stearns disclosed that two of its hedge funds had "lost nearly all of their value." Combined, these funds had held billions of dollars. Now they were essentially worthless.

The Dominoes Begin to Fall

The hedge fund collapse set off a cascade of consequences.

Investors sued. The law firms of Jake Zamansky & Associates and Rich & Intelisano filed arbitration claims alleging that Bear Stearns had misled investors about its exposure to risky mortgages. Barclays Bank, the British financial giant, claimed in its lawsuit that Bear Stearns managers had deliberately used one fund "as a repository for risky, poor-quality investments" while telling investors the fund was profitable.

Executives fell. Warren Spector, co-president of Bear Stearns, was asked to resign on August 5, 2007, taking the blame for the hedge fund disaster.

Profits evaporated. In September, Bear Stearns reported a sixty-one percent drop in quarterly profits. By November, the firm was writing down another $1.2 billion in mortgage-related securities and facing its first loss in eighty-three years of operation.

Credit ratings agencies took notice. Standard & Poor's downgraded Bear Stearns from AA to A. This might sound like a minor change—both grades still indicate a strong company—but in the world of institutional finance, such downgrades matter enormously. Many pension funds and insurance companies can only do business with firms above certain rating thresholds. A downgrade can cut off a firm from billions of dollars in business relationships.

The Rumor Becomes Reality

By March 2008, something toxic was spreading through Wall Street: fear.

Rumors circulated that Bear Stearns was in trouble. Other financial institutions grew nervous about doing business with the firm. In the arcane world of investment banking, firms constantly borrow from and lend to each other in overnight transactions. They trade complex financial instruments that require trusting your counterparty to hold up their end of the deal. When that trust evaporates, the entire system can seize up.

Christopher Cox, chairman of the Securities and Exchange Commission—the government agency that regulates Wall Street—later said something remarkable about Bear Stearns' collapse. The firm didn't fail because it ran out of capital, Cox explained. It failed because it ran out of confidence.

"Notwithstanding that Bear Stearns continued to have high quality collateral to provide as security for borrowings," Cox said, "market counterparties became less willing to enter into collateralized funding arrangements with Bear Stearns."

In plain English: other banks stopped lending to Bear Stearns even when Bear Stearns offered to put up valuable assets as security. The fear had become irrational—but it was also self-fulfilling. When everyone believes a bank will fail, everyone pulls their money out, and the bank fails.

The numbers tell the story with brutal clarity. On March 10, 2008, Bear Stearns had $18.1 billion in available cash. On March 13, it had $2 billion.

Eighty-nine percent of the firm's liquidity—its ability to meet short-term obligations—had vanished in three days.

The Fed Steps In

On Friday, March 14, 2008, the Federal Reserve Bank of New York offered Bear Stearns an emergency lifeline: a $25 billion loan to provide liquidity for up to twenty-eight days.

The loan came with conditions. Bear Stearns had to put up unencumbered assets—valuable holdings that weren't already pledged as collateral for other loans—as security. But at least it bought time. Or so it seemed.

Within hours, the Fed changed its mind. The twenty-eight-day loan was off the table. Instead, a far more drastic solution was taking shape.

The Federal Reserve would create a special company, eventually named Maiden Lane LLC, to buy $30 billion worth of Bear Stearns' assets. (The name came from a street in lower Manhattan near the New York Fed's headquarters—a dry bit of bureaucratic naming for what was essentially an emergency bailout vehicle.) JPMorgan Chase, another giant Wall Street bank, would buy what remained of Bear Stearns.

The price? Two dollars per share.

To grasp the magnitude of this collapse: Bear Stearns stock had traded at $172 per share in January 2007. It was at $93 as recently as February 2008. Now shareholders were being offered $2—less than seven percent of the company's market value from just two days earlier.

The Deal That Almost Fell Apart

Shareholders were furious. A class action lawsuit challenged the terms of the acquisition. The deal's structure contained what was later characterized as a "loophole"—an open-ended guarantee that created problems because the acquisition still required shareholder approval. Jamie Dimon, JPMorgan's chief executive, was reportedly "apoplectic" about mistakes in the hastily drafted contract.

On March 24, JPMorgan raised its offer to $10 per share—still a catastrophic loss for anyone who had bought Bear Stearns stock at its peak, but five times the original offer. The revised deal valued Bear Stearns at $1.2 billion, roughly what its Manhattan office building alone was worth.

The final structure of the rescue was intricate. The Federal Reserve provided a $29 billion loan to Maiden Lane LLC, the entity holding Bear Stearns' toxic assets. JPMorgan contributed a $1 billion subordinated loan, meaning JPMorgan's money would absorb losses before the Fed's money was at risk. In exchange, the Fed could not seize JPMorgan's assets if the underlying mortgages went bad.

Federal Reserve Chairman Ben Bernanke defended the bailout. A Bear Stearns bankruptcy, he argued, would have affected the real economy and could have caused a "chaotic unwinding" of investments across American markets.

He was probably right. Six months later, when the government let Lehman Brothers—a similar investment bank—go bankrupt rather than arranging a rescue, global financial markets went into freefall.

The Human Wreckage

For the executives who ran Bear Stearns into the ground, consequences varied.

James Cayne had been chief executive from 1993 to 2008, presiding over both the firm's rise and its catastrophic fall. Time magazine later named him the CEO most responsible for the 2008 financial crisis, writing that "none seemed more asleep at the switch than Bear Stearns' Cayne." As of December 2007, Cayne owned nearly five percent of Bear Stearns—a stake worth over $1 billion at the stock's peak, reduced to roughly $60 million by the JPMorgan deal.

Matthew Tannin and Ralph Cioffi, the managers of the failed hedge funds that triggered Bear Stearns' downfall, were arrested in June 2008 on criminal charges. Prosecutors alleged they had misled investors about the risks in their portfolios. A jury found them not guilty. Civil lawsuits continued for years.

Joseph Lewis, a British billionaire currency trader, had accumulated over nine percent of Bear Stearns stock by December 2007. He lost hundreds of millions of dollars when the stock collapsed.

The fifteen thousand five hundred Bear Stearns employees scattered. Some were absorbed by JPMorgan Chase. Others moved to competing firms. Many left Wall Street entirely.

In January 2010, JPMorgan stopped using the Bear Stearns name. An eighty-seven-year-old brand disappeared from the financial world.

What Killed Bear Stearns?

Depending on whom you ask, Bear Stearns died from different causes.

The official explanation focuses on liquidity and confidence. The firm had assets but couldn't convert them to cash fast enough when counterparties fled. Rumors became self-fulfilling prophecies. It was a classic bank run in modern Wall Street clothing.

A deeper analysis points to leverage and risk management. Bear Stearns had bet massively on mortgage securities, doubling down even as warning signs flashed. The firm's leverage ratio of nearly 36 to 1 left no margin for error. When mortgage values dropped, there was nothing to absorb the blow.

Some critics blamed regulatory failures. The Securities and Exchange Commission supervised Bear Stearns but didn't catch—or didn't stop—the dangerous buildup of risk. Former Fed Chairman Paul Volcker said the central bank had taken actions "at the very edge of its lawful and implied powers" in orchestrating the rescue.

A journalist named Matt Taibbi argued in Rolling Stone that naked short selling—a controversial trading practice where investors bet against stocks they haven't actually borrowed—helped drive Bear Stearns and Lehman Brothers into the ground. Academic researchers at the University of Oklahoma studied the trading data and found "no evidence that stock price declines were caused by naked short selling."

Perhaps all these explanations contain part of the truth. Bear Stearns was overleveraged, overexposed to toxic mortgages, and operating in a financial system where confidence could evaporate overnight. When the dominoes started falling, there was no way to stop them.

The Prelude to Catastrophe

Bear Stearns' collapse in March 2008 was a warning shot. Six months later, Lehman Brothers would fail, triggering a global financial crisis that would destroy trillions of dollars in wealth, throw millions of people out of work, and reshape economies around the world.

The irony is thick. Bear Stearns was rescued, absorbed into JPMorgan Chase, its employees and counterparties largely protected from the worst consequences. Lehman Brothers was allowed to fail, and the resulting chaos nearly brought down the entire financial system.

What made Bear Stearns worth saving and Lehman Brothers expendable? The honest answer is that policymakers were improvising. There was no playbook for the crisis they faced. The Bear Stearns rescue was an experiment. By the time Lehman failed six months later, political opposition to bailouts had hardened, and the government let it go.

Both decisions had consequences that still echo today. The Bear Stearns rescue established that the government would intervene to prevent major financial firms from failing—a precedent that critics call "moral hazard" because it encourages risky behavior. The Lehman collapse demonstrated what happens when the government doesn't intervene—a lesson that cost the global economy trillions.

Somewhere between those two poles lies the challenge of regulating modern finance: how to let firms fail when they make bad bets, without bringing down the entire economy in the process.

Bear Stearns survived the crash of 1929. It didn't survive the crash of 2008. The firm's eighty-five-year history ended not with a bang but with a fire sale—$10 per share, roughly the price of a movie ticket, for a company that had once been worth billions.