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.