Bear Stearns – What is it, definition and concept | 2022

Bear Stearns was an American investment bank created in 1923. Its bankruptcy was the prelude to the great financial crisis of 2008.

Due to its activity, mainly focused on securitization, Bear Stearns was highly exposed to subprime mortgages.

It is true that the bank, created in 1923, had managed to emerge unscathed from the Great Depression and the stock market crash of 1987, but it could not survive the subprime mortgages.

With its bankruptcy, in March 2008, the first chapter of a very harsh financial crisis was written that broke out just six months later, in September 2008.

The Bear Stearns Road to Disaster

Bear Stearns was a large American banking entity, making it the fifth largest investment bank in the United States. In fact, its volume of business had grown thanks to mortgage-backed securities. What’s more, before the mortgage crisis, Bear Stearns’ mortgage department was making more than a healthy income.

Senior managers at Bear Stearns had made a big bet on mortgage-backed securities. Those responsible included executives such as Jimmy Cayne, Alan Greenberg, Warren Spector and Alan Schwart.

The objective of such a decision was to achieve banking leadership in this type of assets.

Bear Stearns’ long history and reputation seemed to give the bank an image of trust and solidity. Investors, meanwhile, were told they were investing in high-quality, low-risk funds backed by excellent ratings from private agencies.

In this way, Bear Stearns, throughout 2006 and 2007, continued with its policy of securities guaranteed with assets, heading towards a more than dangerous scenario.

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The first victim of the financial crisis

However, the first problems began when two Bear Stearns hedge funds set off alarm bells. These were the Bear Stearns High-Grade Structured Credit Fund and the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund.

The situation was dire, and Bear Stearns was said to be highly exposed to junk mortgages. In other words, the value of the assets (mortgages backing his securities) had plummeted. It seemed that those two high-risk funds would not be able to renew their loans while mistrust hovered over the bank.

Meanwhile, investment banks were experiencing significant liquidity problems and did not have the option of requesting help from the Federal Reserve. Rumors haunted Bear Stearns. The shares began to fall in value as they tried to reach a deal with JP Morgan, which was only offering $2 a share. Ultimately, the issue was settled by setting the price at $10 per share. In this way, JP Morgan ended up taking over Bear Stearns.

Similarly, the Federal Reserve also ended up taking action on the matter, enabling a line of credit for JP Morgan to take control of Bear Stearns.

Despite the fall of Bear Stearns, there was a belief that the downturn would be overcome, that a financial crisis would not occur and that the housing bubble would continue. And it is that it was considered that what happened with Bear Stearns was a specific case.

In this context, between March and July 2008, the markets went through a brief period of growth. But the reality was much bleaker, and investment banking giants like Lehman Brothers were heavily exposed to subprime mortgages, sparking the 2008 financial crisis and a great recession.

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Impact

Bear Stearns was the first Wall Street bank to fail in 2008 as a result of its high exposure to subprime mortgages. Its collapse would be the first step in the collapse of a series of investment banks highly linked to junk mortgages.

At the judicial level, Ralph Cioffi and Mathew Tannin, two of the managers of the hedge funds that led to the collapse of Bear Stearns, were tried in 2009. Their speculative operations were considered to have caused investors losses of between 1,400 and 1,600 million euros. Finally, the justice ruled that both directors were innocent.

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