Bear Sterns Collapse, How it

Bear Sterns Collapse, How it Happened and What it Caused

The fall of Bear Stearns -- Why the unthinkable occurred

Types of securities in which Bear Stearns was investing

Bear Stearns fund managers had purchased collateralized debt obligations on subprime, mortgage-backed securities, paying an interest rate over and above the cost of borrowing. They used their leverage to buy more than they could pay with their immediately available capital, expecting a high rate of return from these trades. Credit default swaps were used as insurance against risk ("Dissecting the Bear Sterns hedge collapse," Investopedia, 2009).

Amount of assets

"Bear was noted for its addiction to leverage even at a time when Wall Street, which runs on debt, was drunk on the stuff. Bear had $11.1 billion in tangible equity capital supporting $395 billion in assets, a leverage ratio of more than 35 to one. And its assets were less liquid than those of many of its competitors" (Boyd 2009).

How they collapsed

The subprime mortgage crisis began to manifest itself as more and more people began to default on their loans. Although the bubble was supposed to 'burst' in the real estate market eventually, Bear Stearns portfolio managers had not anticipated this, and had insufficient credit insurance to protect themselves against their losses. Their creditors on the leveraged investments demanded that Bear Stearns provide additional cash on their loans because the collateral (subprime bonds) was rapidly falling in value ("Dissecting the Bear Sterns hedge collapse," Investopedia, 2009). However, Bear did not have enough available cash to quell its investor's fears.

Chain of events

On March 10, 2008,-word leaked out that a major bank refused to loan Bear Sterns $2 billion for a securities-backed repurchase (or "repo") loan, which are "crucial for investment banks, which borrow and lend billions to fund their daily business" (Boyd 2008).

On March 11, 2008, banks refused to issue any further credit protection on Bear's debt at any rate of interest. On March 12, more investors took their money out of Bear as rumors confirmed that Goldman and Sachs would no longer protect its investors from losses on Bear derivatives deals. On March 14, 2008, Bear's stock dropped nearly 40% in the first half-hour of trading, effectively tolling the death-knell of Bear's existence as an independent entity (Boyd 2008). Only a temporary loan from J.P. Morgan Chase and the Federal Reserve Bank of New York prevented Bear from going bankrupt immediately.

Who was affected and what happened in the markets

Both investors and employees were affected: "I worked eight years at a firm that promoted me from the back office to investment banking," said one managing director, "I had thousands of shares and thought I could afford to send my kids to private schools and college. It's all gone now." (Boyd 2008). On Wall Street as a whole, pain and suffering reigned: the Dow Jones fell by as much as 300 points at one point and eventually closed 194 points lower. The repercussions were felt around the world: In London, the FTSE 100 fell 150 points and the Japanese Nikkei fell 454 points (Stepek 2008)