\nBear Stearns was the smallest (but still enormous) member of the 5 major U.S. investment banks [1]. It sat in the middle of the global financial markets, operating various business lines across a number of geographies.<\/p>\n
![\"Picture3\"](\"https:\/\/i4tsk12in2b2y7uts14c528g-wpengine.netdna-ssl.com\/wp-content\/uploads\/sites\/4\/2015\/12\/Picture31.jpg\")
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The Company earned its reputation largely through the strength of its Sales & Trading business. The division, Bear\u2019s largest, served as a middle man in the financial markets. When clients (e.g. such as investment\u00a0funds and other brokers) wanted to trade\u00a0financial securities, Bear would commit\u00a0to buy from or sell to them as a trusted intermediary, pocketing the difference between the prices at which it bought\u00a0and sold.\u00a0The firm also profited from its own bets placed in the market. The\u00a0vast majority of the securities traded\u00a0consisted of complex and long-term instruments such as bonds, mortgages, and esoteric financial products. Each day, billions of\u00a0dollars of these financial securities flowed through Bear\u2019s trading desks.<\/p>\n
What\u2019s the Problem?<\/strong> Despite the enormous volume of trades, Bear earned only a small percentage on each trade. In order to generate the returns required to stay\u00a0competitive in\u00a0the industry, Bear (like other investment banks) borrowed an immense amount of money to support its operations. At the end of\u00a02007, Bear owned $395 billion of assets, of which only $12 billion was supported by its own capital. In other words, for every $1 Bear used, it borrowed an additional $32. This ‘financial leverage’ magnified returns, allowing the Company to turn a business that collected pennies into a very\u00a0profitable venture.<\/p>\n In the debt markets, it\u2019s often true that the shorter the duration of a loan, the cheaper it is.\u00a0Unsurprisingly, Bear went as short as possible. Despite the \u2018investment bank\u2019 moniker, Bear was not actually a bank; it did not have access to federally insured bank deposits. Instead, much of its debt (~$125 billion) was comprised of \u2018repo agreements\u2019 \u2013 loans that lasted only a few days, sometimes even overnight \u2013 that Bear would continually \u2018roll\u2019 (i.e. renew) daily. Effectively, Bear\u2019s lenders had to give the Company a vote of confidence every morning before it\u00a0could open for business.<\/p>\n To most,\u00a0this model should raise eyebrows. Bear Stearns was in the business of trading and investing in long term assets that could not be sold quickly or easily, but chose\u00a0to use very short-term debt in prodigious amounts to operate that business<\/span>. This model was predicated on the collective trust of its lenders and trading clients…their trust\u00a0that when they asked for their money back, Bear could provide it.<\/p>\n Now You See it\u2026<\/strong> Where Do We Go From Here?<\/strong> Today, in an effort to rationalize their models, most banks have significantly reduced their use of debt and favor more stable, reliable forms of debt over\u00a0short-term \u2018repo\u2019 loans. Let us hope that the management teams, and the regulators who oversee them, do not forget the lessons learned from Bear Stearns.<\/p>\n ———<\/p>\n Notes:<\/strong><\/p>\n Sources:<\/strong><\/p>\n A look into the sudden collapse of the $400 billion Wall Street giant.<\/p>\n","protected":false},"author":601,"featured_media":3722,"comment_status":"open","ping_status":"closed","template":"","categories":[],"class_list":["post-3548","hck-submission","type-hck-submission","status-publish","has-post-thumbnail","hentry"],"connected_submission_link":"https:\/\/d3.harvard.edu\/platform-rctom\/assignment\/the-tom-challenge-tom-winners-and-losers-assignment\/","yoast_head":"\n
\nHow a firm finances its operations is often perceived as secondary to the actual operations, but for an investment bank like Bear Stearns, how it financed its business was fundamental<\/em> to its operations. And it was in this aspect that Bear\u2019s business and operational models diverged.![\"Leverage\"](\"https:\/\/i4tsk12in2b2y7uts14c528g-wpengine.netdna-ssl.com\/wp-content\/uploads\/sites\/4\/2015\/12\/Leverage1.jpg\")
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\nIn March 2008, Bear Stearns lost that trust. On Monday the 10th, an otherwise unremarkable day, rumors inexplicably began coursing through Wall Street that Bear was running out of cash. The bank certainly had recent stumbles, but it was profitable and sat on a comfortable cash cushion of $18 billion<\/em>. Despite these facts, the unfounded rumors grew and eventually led to a rout. Clients clamored for their money and refused to trade with Bear, and its lenders refused to roll their loans. And though Bear’s assets were worth more than its obligations, it wasn\u2019t able to cash out of those investments quickly enough to replenish\u00a0its hemorrhaging cash reserves. By that weekend, the rumors became self-fulfilling\u00a0– Bear had run\u00a0out of cash. JP Morgan (with the government\u2019s help) had to swoop in and acquire the imploding Bear Stearns for $2\/share, down from the $70\/share it had been at the beginning of the week [2].![\"Stock](\"https:\/\/i4tsk12in2b2y7uts14c528g-wpengine.netdna-ssl.com\/wp-content\/uploads\/sites\/4\/2015\/12\/Stock-Price.jpg\")
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\nThere were a number\u00a0of other business and oversight issues that contributed to the Bear Stearns’\u00a0woes, but ultimately, a\u00a0precarious operating model that didn’t support the business model allowed the Company\u00a0to be brought to its knees by nothing more than rumors.<\/p>\n\n
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