Bear Stearns

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~ the last words ~

Bear Stearns opened on 1 May 1923 as an equity trading house with $500,000 of capital and three partners whose relations were poor enough to produce at least one public scuffle. It came through the 1929 crash without laying anyone off, opened a Chicago branch by 1933 and an Amsterdam office in 1955, and went public in 1985. Alan Greenberg ran it from 1978 to 1993 and James Cayne from 1993 to 2008. By 2007 it employed more than fifteen thousand five hundred people worldwide and Fortune's annual survey had named it the most admired securities firm in America twice in three years.

The mortgage exposure surfaced in the summer of 2007 through two of its own hedge funds. On 22 June the firm pledged a collateralized loan of up to $3.2 billion to rescue the High-Grade Structured Credit Fund, into which it had originally put $25 million of its own money, because the alternative was a forced liquidation of thinly traded collateralized debt obligations that would have required every bank holding similar paper to mark it down. By the week of 16 July both funds had lost nearly everything. A co-president was asked to resign on 5 August. On 15 November the firm disclosed another $1.2 billion of write-downs and the first loss in its eighty three year history, and Standard and Poor's cut the rating from AA to A.

The end took one week in March 2008. The liquidity pool stood at $18.1 billion on 10 March and $2 billion on 13 March. On 14 March the New York Fed agreed a twenty eight day loan and then withdrew it. On Sunday 16 March the firm was sold to JPMorgan Chase at $2 a share, raised to $10 on 24 March, approved by shareholders on 29 May and effective the following night. The date most people outside finance remember from 2008 is September, and at the time this one was read as one firm's problem rather than the opening of anything.

~ the record ~

~ the seventy two hours ~

The mechanism was built over a weekend. The Fed created a vehicle called Maiden Lane LLC to take $30 billion of Bear Stearns assets off the books, funded with a $29 billion first priority loan from the New York Fed and $1 billion subordinated from JPMorgan, structured so that JPMorgan's loss came first and the Fed could not reach any of JPMorgan's other assets if the collateral fell short. Ben Bernanke defended the arrangement on the grounds that a Bear Stearns bankruptcy would have reached the real economy and could have caused a chaotic unwinding across American markets.

Christopher Cox, chairman of the SEC, gave the official diagnosis on 20 March. The collapse came from a lack of confidence rather than a lack of capital, Bear Stearns still held high quality collateral against its borrowings, and what changed was that counterparties stopped being willing to lend against it. Rumors about the firm's liquidity became true by being believed. The cash pile fell by eighty nine percent in three business days without a single default on the firm's own paper.

Matt Taibbi argued in Rolling Stone that naked short selling had done the work. Finance researchers at the University of Oklahoma went through the trading in financial stocks including this one and found no evidence that the price declines were caused by it. What is not in dispute is the speed. The firm went from a Fortune ranking as the most admired securities house in the country to a two dollar offer in about fifteen months.

~ the leverage number ~

At the end of fiscal 2007 the balance sheet carried roughly $395 billion of assets against $11.1 billion of equity, a ratio of 35.6 to one, which means a fall of under three percent in the value of the assets erases the firm. More than $28 billion of those assets were level three, the accounting category for things with no observable market price, valued by the holder's own model. The notional amount of derivative contracts on the books a year earlier was around $13.4 trillion, of which $1.85 trillion were exchange listed and the rest were agreements with named counterparties who could decline to renew them.

~ the drafting mistake ~

The merger agreement was written in about thirty six hours by Wachtell, Lipton, Rosen and Katz, and it contained a guarantee with no end to it: JPMorgan would stand behind Bear Stearns trading obligations whether or not the shareholders approved the sale. That left the shareholders free to vote the deal down and keep the guarantee, which is the opposite of what the buyer had intended to sign. A class action challenging the terms was filed on 24 March. The same day the price went from $2 to $10 a share, a total of $1.2 billion, and Jamie Dimon was described by people around him as apoplectic about the error.

So the price of the fifth largest investment bank in the United States moved by a factor of five in eight days, for reasons that had nothing to do with the assets and everything to do with how fast a contract could be typed on a Sunday.

~ what the rescue set up ~

Paul Volcker, who had run the Federal Reserve for eight years, said on 8 April 2008 that the actions taken here extended to the very edge of the Fed's lawful and implied powers. The practical effect of the rescue was to tell everyone holding paper from a large broker-dealer that a large broker-dealer would be caught, and that assumption held for exactly six months. The headquarters at 383 Madison Avenue is a JPMorgan building now. JPMorgan stopped using the name in January 2010, eighty seven years after Joseph Bear opened the doors.

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