Rohit's nukkad

Friday, March 28, 2008

The Bear Stearns Fiasco

Everyone is aware of the current Subprime mortgage crisis leading the US economy into a possible recession (or are we already in a recession). But a lot of people like me were surprised with the Bear Stearns, one of the largest global investment bank taken over by JP Morgan Chase with the help of Federal Reserve backing, couple of weekends back for $2 per share. How can a company being traded for $172 a share in January 2007 or $93 a share in February 2008 be sold out for such an outrages price on 14th March 2008.

With this post I will try to answer the Bear Stearns mess. Before we begin lets have an overview of the company.


Bear Stearns was founded in 1923 as an equity trading house. The company has headquarters located in Manhattan, NY with a number of offices in US and internationally.

Bear Stearns operates as an investment banking, securities and derivatives trading, and clearing and brokerage company serving governments, corporations, institutions and individuals worldwide. Based on 2006 revenue distributions the company has 80% business in capital markets, under 10% in wealth management and about 12% in clearing services.

In 2005-2007, Bear Stearns was recognized as the "most admired" securities firm in Fortune's "America's Most Admired Companies" survey, and second overall in the security firm section. The company holds this distinction second time in the past three years.

Bear Stearns and subprime mess

The first cracks of subprime mess were seen in Bear Stearns as early as June 2007. The company pledged a collateral loan of $3.2 billion to bail out one of its funds. But when things didn't work out in July 2007 it disclosed that two subprime hedge funds had lost nearly all of their value. And this was just the beginning of the bad news for Bear Stearns. The following are highlights of what followed July 2007.

1. In Aug 2007, investors in the two funds took action against Bear Stearns
2. In Sept 2007, there was a reported 60% drop in net profits of Bear Stearns due to the hedge funds losses
3. The company's credit ration was lowered from AA to A by Standard & Poor's credit rating with AAA being the highest safety rating and D being the lowest with anything lower than BBB considered as junk bond)
4. In Nov 2007, the company reported a $1.2 billion losses related with mortgage-related securities, their first loss in 83 years.

So the writing was on the wall. Further pointers about the mess was seen a week before the purchase.

1. The week before it was sold Bear Stearns shares were trading at $76 a shared on Thursday and $30 on Friday.
2. The talks of the company having liquidity problems were making rounds, making its clients and lenders to withdraw their money from the firm leading to drastic loss in share value.
3. Bear Stearns with its bad investments had in totality $31 in debt per $1 it had.

So if the Federal Reserve wouldn't have stepped in and had make the take over a possibility over the weekend then over the course of the week Bear Stearns would have collapsed under the weight of its own problems and the effects would have been even more devastating.

Bear Stearns would have eventually file for bankruptcy freezing its client assets. Thus leading to taxpayers footing in the bill for assets which the Federal insured in the bailout. And the panic which this would have caused would have spell devastation beyond words.