Mortgage-backed securities that began to lose value in September 2006 when home prices began to fall. This was the beginning of the subprime mortgage crisis.
On June 7, Bear Stearns froze payments to investors in these funds and provided one of the funds with a $1.6 billion loan. Bank of America guaranteed the funds' loans of $4 billion. On June 20, Merrill Lynch sold a portion of its shares in the two funds. On July 31, both hedge funds filed for bankruptcy.
In October 2007, Bear Stearns entered into a partnership with China's CITIC Securities Co. in order to receive an infusion of much-needed cash.
In November 2007, the Wall Street Journal published an article criticizing Bear CEO James Caine. It accused Kane of playing bridge and smoking weed instead of focusing on saving the company. The article further damaged Bear Stearns' reputation.
On December 20, 2007, Bear Stearns posted its first ever loss.
In the fourth quarter, Bear Stearns lost $859 million and announced a write-down of $2 billion in subprime mortgage assets. Moody's downgraded the company's rating from A1 to A2.
In January 2008, Moody's downgraded Bear's mortgage-backed securities to B or below, which is a junk bond. As a result, Bear had trouble raising enough capital to stay afloat. Bear CEO James Cain stepped down and was replaced by Alan Schwartz.
federal rescue
On Monday, March 10, 2008, many of Bear's trading partners decided to end their relationship with the bank. This left Bear in a difficult position as he only had $18 billion in cash reserves.
On March 11, 2008, Moody's downgraded Bear's MBS rating to B and C. These two events triggered an old-fashioned banking crash and clients withdrew their deposits and investments.
By March 13, Bear Stearns had only $2 billion in cash left. How did it happen so quickly? Bear was losing cash when other banks withdrew their buyback agreements and refused to make new loans. Nobody wanted to get involved in Bear securities.
repurchase agreements. As part of the repurchase agreement, the dealer exchanges its securities for cash from other banks. When the buyback agreement expires, the banks reverse the transaction and the lender receives a quick and easy premium of 2-3%.
Bear's CEO realized he didn't have enough cash to open the business on March 14th. He approached Bear's bank, JP Morgan Chase, for a $25 billion overnight loan. Chase CEO Jamie Dimon needed more time to study Bear's true value before making a commitment. He asked the Federal Reserve Bank of New York to guarantee a loan so Bear could reopen on Friday.
Without the intervention of the Fed, the failure of Bear Stearns could have spread to other banks. These included money market funds used by small businesses.
At 9:15 am on March 14, the Fed board held an emergency meeting. He approved a discount window loan to Chase for the transfer of Bear. The amount was capped by Bear's collateral, and Chase could default on the loan if Bear didn't have enough assets to repay it.
The Fed used its section 13(3) lending authority to bail out Bear. This allows the Fed to lend to any private company with sufficient capital, but it cannot buy the company's shares or guarantee its assets. The last time the Fed used this power was to bail out banks during the Great Depression.
On March 16, Chase announced the purchase of Bear for $236 million. He purchased Bear for $2 a share, which is the March 15 closing price. This was a sharp drop from the $170 price that Bear stock was worth a year earlier.
The Fed loan given to Chase on March 14 was repaid on March 17. The Fed's board met on March 16 to approve a $30 billion loan to Chase in exchange for Bear's assets. The Fed will be able to sell assets at a higher cost in a few years when the market improves.
Fraud disclosure
On June 19, 2008, the Securities and Exchange Commission accused the managers of two hedge funds of fraud. Both managers, Ralph Cioffi and Matthew Tannin, lied about how bad things were for the funds. What they didn't tell investors was that the Enhanced Leverage Fund fell 18.97% in April 2007. Instead, they said that returns were on par with March.
They also lied about how much money was invested in subprime mortgages. They said that only 6%-8% of the fund's portfolio was subprime. Instead, they stated that 60%.
Impact of the collapse of Bear Stearns
The collapse of Bear Stearns caused a panic on Wall Street. Banks have realized that no one knows where all the bad debts are hidden in the portfolios of some of the most respected names in the business. This triggered a banking liquidity crisis that made banks unwilling to lend to each other.
Chase CEO Jamie Dimon regrets buying Bear Stearns and another failed bank, Washington Mutual. Both cases cost Chase US$13 billion in legal fees. The end of failed Bear deals cost Chase another $4 billion. Investors lost confidence as Chase took over the dubious assets of Bear. This lowered Chase's stock price for at least seven years.
