Who is Bear Stearns:
Bear Stearns pioneered the capital and asset-backed security market till early 2007. It is one of the oldest investment bankers of Wall Street in the US. Being viewed as a blue-chip financial stock, it was one of the most respected company as well. "America's most admired company" survey crowned Bear Stearns as the "Admired Firm" in securities firm.
From hero to zero,
No sooner Bear Stearns stuck down and touched the ground. On March 16' 2008, the company was suddenly declared to be bankcrupt and the prices of the share was down to $2 per share. It was heart-breaking for all its share holders, because even four days before this declaration, the price per share was around $61.58.
It was unbelievable that one of the oldest and strongest company of US is closing down all of a sudden. Private bankers and financial institutions like Barclays, were all analysing about they taking over of Bear. Atlast it was clearly known that Federal Reserve and JP Morgan only stood up to wholly rescue Bear Stearn.
Trying to look what happened , what was the root cause …..
From an article in USAToday dated 3/19/2008, says that the reason for downfall of the company is that, it has provided loans to poor credit holders. Meantime the prices of the houses came down in real estate market.
Investors of Bear Stearns firmly believed that the company will not be able to repay any of its loans, including short-term and overnight loans. The Fed Reserve Bank came into the scene to rescue Bear. But worst case, the investors said that the Bank cannot stand behind any of the agreements made by Bear with other financial institutions, because of their complexity. Still withstanding the situation, Fed Bank agreed to fund about $30 billion dollars in equivalency of Bear's assets. Those assets cannot be liquidated very quickly by selling them, as the real estate market was very dull that time. In another point of view, as the house prices were very cheap, more people tend to buy houses. Taking advantage of that psychology, long-term loans for sanctioned for people, who wouldn't have been qualified for an investment season before the crisis of Bear.
In a legal case filed against Bean Stearns officers and directors states that, the company has issued many false financial statements that misleads their capital and profit figures. It charges that Bean had artificially inflated its share prices, like the one of $159.36 per share in April'2007.
In an analysis done by Mr. Bill Bonner for "The Daily Reckoning" states that the root cause for all this downfall is nothing but the increase in sub-prime mortgage lending. Sub-prime mortgage lending is about lending fast loans with less documentation. There are list of companies which crashed down for working primarily with sub-prime mortgages. First of all is the North-America's HSBC, next comes the New Century Financial ($23 billion debt) and the like.
An example which exposes the actual gap for this breakage is as follows. A house in Allenhurst St., Door no. 2909 in a sale poster says that, the house for sold for a rate of $264,000 in September 2005. The buyer of the house got a loan from its sub-prime lender and was not able to repay his instalment. Therefore this stands as a bad debt to the company. Trying to resell the property now it is valuable only for $225,000 in the estate market. What a loss to the investor!!
Multiplying such losses in hundreds and thousands of properties big to small, it fairly brings a bad debt sum which is too high for any financial company to withstand.
Hedge Funds
In another case filed against Bear Stearns states that the Company had failed to inform the market of the problem's in the company's hedge funds. So what is this hedge funds? It is an investment strategy where in high funds with high risk are invested into the market expecting high returns to their investors. A manager who attains his target in catching customers and lending loans gains a 20% incentive compared to a manager in the normal banking process receiving 0% incentive. Deeply investigating what makes the investors to take such high risk is that, the borrower of the loan is indirectly paying an interest amount more than his loan amount and the cost of borrowing the loan. Credit cards system which has credit and cash limits, charges 3% interest for the credit loans and 5% interest for the cash loan used from the card by its owner. Hence just imagine the returns gained by this process. Calculating this way the company worked out to build more, but unfortunately failed as most of its customers were not capable to repay their debts.
Major mistakes made by Bear Stearns:
Failure to predict the behaviour of subprime bond market in worst conditions, alternatively extreme conditions.
Liability was more than Assets, particularly liquid assets. Therefore they failed to face their debt obligations, as they did not have ample liquidity of funds. If they would maintained enough funds, then such a pathetic condition wouldn't have covered the 53-storey building in Wall Street.
The fund managers did not do a good job. Macroeconomic researches made by them were not effective, otherwise they would have clearly understood that the subprime market is going to be tough enough sooner. When the housing market went up, and subprime borrowers were susceptible in US economy downfall in 2005, they should have been a bit alert.
Conclusion:
Few words to conclude saying that the company in terms of its fund managers and directors were greedy after money. They charged very high fees for the loan application processing and aimed for 20% potential profit from all their investment. This was the major psychological effect that made them fall down in the streets of New York. Hence the hero to zero story of Bear Stearns, the now called JP Morgan Securities.
