The collapse of Bear Stearns

Bear Stearns was founded as an equity trading house on May Day 1923 by Joseph Bear, Robert Stearns, and Harold Mayer with $500,000 in capital. By 1933, Bear had opened its first branch office in Chicago. In 1985, Bear Stearns became a publicly traded company. In 2005-2007, Bear was recognized as the "Most Admired" securities by Fortune.
The sub prime crisis changed the fortunes of Bear dramatically. On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, the High-Grade Structured Credit Fund, while negotiating with other banks to loan money against collateral to another fund, the High-Grade Structured Credit Enhanced Leveraged Fund.

During the week of July 16, 2007, Bear disclosed that the two subprime hedge funds had lost nearly all of their value amid a rapid decline in the market for subprime mortgages.On August 1, 2007, investors in the two funds took action against Bear and its top board and risk management managers and officers. Two law firms filed arbitration claims with the National Association of Securities Dealers alleging that Bear had misled investors about its exposure to the funds. As a result of the huge hedge fund write downs and its first loss in 83 years, Standard & Poor's downgraded Bear’s credit rating from AA to A.

Co-President Warren Spector was asked to resign on August 5, 2007. Matthew Tannin and Ralph R. Cioffi, both former managers of hedge funds at Bear Stearns Companies, were arrested June 19, 2008, on criminal charges and for misleading investors about the risks involved in the subprime market. Tannin and Cioffi were also named in lawsuits brought forth by Barclays Bank, who claimed they were one of the many investors misled by the executives. They were also named in civil lawsuits brought in 2007 by investors, including Barclays, who claimed they had been misled. Barclays claimed that Bear knew that certain assets in the High-Grade Structured Credit Strategies Enhanced Leverage Master Fund were worth much less than their professed values. The suit claimed that Bear’s managers devised "a plan to make more money for themselves and further to use the Enhanced Fund as a repository for risky, poor-quality investments." Bear had apparently told Barclays that the enhanced fund was up almost 6% through June 2007 — when "in reality, the portfolio's asset values were plummeting."

As of November 30, 2007, Bear had notional contract amounts of approximately $13.40 trillion in derivative financial instruments. In addition, the investment bank was carrying more than $28 billion in 'level 3' assets on its books at the end of fiscal 2007 versus a net equity position of only $11.1 billion. This $11.1 billion supported $395 billion in assets, implying a leverage ratio of 35.5 to 1. This highly leveraged balance sheet, consisting of many illiquid and potentially worthless assets, led to the rapid dilution of investor and lender confidence.
In early 2007, the typical price of a credit default swap, (cost of credit protection) tied to the debt of an investment bank like Bear had been about 25 basis points. By March 14 2008, the cost of buying protection on Bear’s debt had increased to 850 basis points[ “Bloomberg Markets”, July 2008].The widening spread predicted a high probability of default. Doubts about the very existence of Bear mounted.

On March 14, 2008, JP Morgan Chase, backed by the Federal Reserve Bank of New York, agreed to provide a 28-day emergency loan to Bear Stearns. Despite this, belief in Bear's ability to repay its obligations rapidly diminished among counterparties and traders. The Fed sensed that the terms of the emergency loan were not enough to bolster Bear. Worried about the possibility of systemic losses if allowed to open in the markets on the following Monday, the US authorities told CEO Alan Schwartz that he had to sell the firm over the weekend, in time for the opening of the Asian market. Two days later, on March 16, 2008, Bear Stearns finalized its agreement with JP Morgan Chase in the form of a stock swap worth $2 a share. This was a huge climb-down for a stock that had traded at $172 a share as late as January 2007 and $93 a share as late as February 2008. In addition, the Fed agreed to issue a non-recourse loan of $29 billion to JP Morgan Chase, thereby assuming the risk of Bear Stearns's less liquid assets. Bernanke, defended the bailout by stating that Bear’s bankruptcy would have affected the real economy and could have caused a "chaotic unwinding" of investments across the US markets.
The collapse of Bear Stearns was as much due to a lack of confidence as a lack of capital. On March 20, Securities and Exchange Commission Chairman Christopher Cox noted that the bank’s problems escalated when rumors spread about its liquidity crisis which in turn eroded investor confidence in the firm. Bear’s liquidity pool started at $18.1 billion on March 10 and then plummeted to $2 billion on March 13. Ultimately, market rumors about Bear Stearns' difficulties became self-fulfilling.

On March 24, 2008, a new agreement raised JPMorgan Chase's offer to $10 a share, up from the initial $2 offer, that meant an offer of $1.2 billion. The revised deal was meant to quiet upset investors and any subsequent legal action brought against JP Morgan Chase as a result of the deal. The higher price was also meant to prevent employees, whose compensation consisted of Bear Stearns stock, from leaving for other firms.