what happened to bear stearns?

picture of bird friend and the oc suburban sprawl

alright, so back to those “undiscovered gems” aka mortgage-backed securities.

fast forward to 2007, when housing prices fell due to increased supply and lower demand, especially in places like nevada. this, coupled with the fact that many of the adjustable rate mortgages given the early 00’s had just adjusted their rates, led to the foreclosure rates hitting a disastrous high. fyi, foreclosure is the process in which the bank repossesses your house after you fail to pay your mortgage. in nevada, the foreclosure rate was up 224% from 2007, which is completely insane when you think about it.

and all those mortgages that went bad meant that all those mortgage-backed securities were worthless, and all the banks that bought them up had to take huge losses in the form of write-downs, which meant *publicly* devaluing the assets they were holding. without going into all the ins and outs of investment banking, let’s just remember that two of the most important “assets” any investment bank can have are consumer confidence and credit strength, which go hand in hand. If you hear that your bank doesn’t have as much money as you thought it did, then you might take your money out, because you're worried about insolvency. which means it WILL have less money, and someone else might follow in your lead. this cycle of declining confidence leading to declining capital and vice versa is called a “bank run” and is disaster for an individual bank and a very bad omen for the rest of the industry. the federal reserve system is set up partially to address these types of banking panics.

in retrospect, we see that bear stearns was particularly vulnerable to a bank run because it was one of the smaller investment banks and it had built up most of its core assets by manipulating the mortgage-derivatives market, so it was not as diversified as many of its peers. the week of March 10th, rumors were floating around rival firms that bear stearns was out of cash and could not even cover day-to-day expenses, which prompted shares to plummet (in this way, finance is like fashion, all about perceptions). the week before, its stock was trading at $70 per share. as these rumors spread, the value dropped to $45 per share and a bank run was imminent, if not already beginning.

as we know now , jp morgan and the federal reserve bank of ny swooped in and brokered a deal to bail out bear stearns. but there were a few other options for how things could have gone.

ps. obviously this issue is infinitely more complex than my basic outline here, but if you want a list of articles to read for deeper analysis, i've saved my own list of research. email me and i'll send it to you.