Bear Stearns

REVIEWED BY JAMES CHEN

Updated Nov 16, 2017

What is Bear Stearns
Bear Stearns was an investment bank located in New York City that collapsed
during the subprime mortgage crisis in 2008. The company was founded in 1923
and survived the Stock Market Crash of 1929, becoming a global investment
bank with branches around the world. Competent management and risk-taking
saw Bear Stearns continue to grow with the global economy. It was one of the
many firms to embrace Lewis Ranieri's securitization of debt to create new
financial products. By the early 2000s, Bear Stearns was among the world's
largest investment banks and a highly respected member of Wall Street's
pantheon of investment banks. Despite surviving and then thriving after the Great
Depression, Bear Stearns was a player in the mortgage meltdown and Great
Recession that followed.

BREAKING DOWN Bear Stearns

Bear Stearns operated a wide range of financial services. Inside this mix were
hedge funds that used enhanced leverage to profit from collateralized debt
obligations (CDOs) and other securitized debt markets. In April 2007, the bottom
fell out of the housing market, and the investment bank quickly began to realize
that the actual risk of these hedge fund strategies was much larger than originally
believed. The collapse of the housing market caught the whole financial system
by surprise, as much of the system was based upon a foundation of a solid
housing market underpinning a solid derivatives market. The Bear Stearns funds
used techniques to further jack up the leverage to these supposed market
fundamentals only to find out that the downside risk on the instruments they were
dealing with wasn't limited in this extreme case of market collapse.

The Bear Stearns Hedge Fund Collapse

The hedge funds using these strategies posted massive losses that required
them to be bailed out internally, costing the company several billion up front and
then additional billion-dollar losses in write-downs throughout the year. This was
bad news for Bear Stearns, but the company had a market cap of $20 billion, so
the losses were considered unfortunate but manageable. This turmoil saw the
first quarterly loss in 80 years for Bear Stearns. Then the ratings firms piled on
and continued to downgrade Bear Stearns' mortgage-backed securities and other
holdings. This left the firm with illiquid assets in a down market. The company ran
out of funds and, in March 2008, went to the Federal Reserve for a credit
guarantee through the Term Securities Lending Facility. Another downgrade hit
the firm and a bank run started. By March 13, Bear Stearns was broke and its
stock plummeted.

JP Morgan Chase Buys Bear Stearns

Bear Stearns was sold to JP Morgan Chase at a fraction of its previous market
capitalization. The Fed lent JP Morgan Chase the money to make the purchase
and it later cost the company several billion to close out the failing trades and
settle litigation against Bear Stearns. The reason Bear Stearns was sold off so
cheaply is that, at the time, no one knew which banks held toxic assets or how
big of a hole these seemingly innocuous synthetic products could knock in a
balance sheet. The illiquidity that Bear Stearns faced due to its exposure to
securitized debt exposed troubles at other investment banks, as well. Many of
the biggest banks were heavily exposed to this sort of investment,
including Lehman Brothers and Merrill Lynch. The collapse of Bear Stearns and
its sale to JP Morgan Chase was the start of the bloodletting in the investment
banking sector, not the end.