Why did the Bear Stearns collapse ? The Summary of Financial Crisis Inquiry Report
Why did the Bear Stearns collapse ? The Summary of Financial Crisis Inquiry Report
Why did the Bear Stearns collapse ? The Summary of Financial Crisis Inquiry Report
Sources:
The financial crisis inquiry report was published in January 2011 by the Financial Crisis Inquiry Commission. You can find more details and the full report at the following links:
The report provides a comprehensive analysis of the causes of the 2008 financial crisis and offers recommendations to prevent similar crises in the future.
Stanford Rock Center: https://fcic-static.law.stanford.edu
This center has amassed a comprehensive archive of FCIC documents related to the financial crisis. You might be surprised by the extensive collection
Yale Program on Financial Stability: https://som.yale.edu/centers/program-on-financial-stability
This web site has very huge resources on the historical interviews of the 2008 financial crisis .
Introduction:
I try to summarize the historical path of the Bear Stearns' collapse, emphasizing the possible causes and reasons for this catastrophic collapse. Bear Stearns was an investment bank specializing in mortgage securitization and brokerage. It was really huge financial company about the numbers that I collected the articles. By November 2006, the company had total capital of approximately $66.7 billion and total assets of $350 billion. The company’s net equity position was only $11.1 billion, and that $11.1 billion supported $350 billion in assets, a leverage ratio of 34.6 to 1. Bear Stearns was the seventh-largest securities firm in terms of total capital and was the second-biggest prime broker in the country, with a 21% market share in 2006, trailing Morgan Stanley’s 23%.1
I think it is imperative to know how Bear Stearns worked in the financial markets. This company was engaged in mortgage securitization during the last three phases of the following pictures.
In mortgage securitization, Bear followed a vertically integrated model that made money at every step, from loan origination through securitization and sale. It both acquired and created its own captive originators to generate mortgages that Bear bundled, turned into securities, and sold to investors.( Financial Crisis Inquiry Commission, page:280 )
Bear had several hedge funds, but two of them were more important and these led to the beginning of Bear's collapse.
June 2007: A Tale of Two Hedge Funds
High-Grade Structured Credit Strategies Fund 2 and High-Grade Structured Credit Strategies Enhanced Leverage Fund3. The Bear Stearns funds collapsed in June 2007 after taking highly leveraged positions in structured securities based largely on subprime mortgage-backed securities.(investor losses of approximately $1.8 billion)
It can be said that the subprime mortgage crisis officially began with the collapse of these funds in the US territory. Obviously, the first cause of this collapse was subprime mortgages and their derivatives.
These funds were involved in the securitization of subprime mortgages and were directly affected by the subprime mortgage crisis. However, I focus on more specific issues such as allegations from SEC reports4:
1- The funds misreprensented the true amount of subprime exposure. The funds held a much greater amount of subprime.
2- The highly leveraged subprime fund with illiquid CDO and CDO2.
3- 90% “AAA" representation was misleading.
4- The hedging strategy with CDS would not protect the Bear Stearn. The bank's exposure to CDS was much higher than its actual exposure to subprime mortgages.
July 2007 - Bankruptcy
The Bear-sponsored hedge funds declared bankruptcy on July 31, 20075.
October 2007
A major money market fund manager, Federated Investors, had decided on October to drop Bear Stearns from its list of approved counterparties for unsecured commercial paper. Fidelity Investments, another major lender, limited its overall exposure to Bear, and shortened the maturities. In October, State Street Global Advisors refused any repo lending to Bear other than overnight.( Financial Crisis Inquiry Commission, page:284 )
December 2007 -Window Dressing
I understand that the SEC wanted Bear's mortgages reduced to lower the leverage ratio. However, Bear used the following tricky method to do so.
Bear would lower its leverage ratio by selling assets, only to buy them back at the beginning of the next quarter. Bear and other firms booked these transactions as sales—even though the assets didn’t stay off the balance sheet for long—in order to reduce the amount of the company’s assets and lower its leverage ratio.( Financial Crisis Inquiry Commission, page:281 )
March 2008 - The problem was Liquidity
Bear was $18 billion in the balance sheet on Monday, March 10 and Moody’s downgraded many of Bear’s mortgage-backed securities to B and C levels (or “junk bonds”).
The Fed announced The Term Securities Lending Facility (TSLF) on March 11. The Term Securities Lending Facility (TSLF) would make available up to $200 billion in Treasury securities, accepting as collateral GSE mortgage– backed securities and non-GSE mortgage–backed securities rated triple-A. The hope was that lenders would lend to investment banks if the collateral was Treasuries rather than other highly rated but now suspect assets such as mortgage-backed securities. The perception that the Fed was acting not to provide liquidity to the MBS market but to save Bear.
On March 12, the SEC noted that Bear paid another $1.1 billion for margin calls from 142 derivatives counterparties.
On March 13, Bear was receiving and meeting significant margin calls, that $14 billion in repo was not going to roll over. On this evening, Bear Stearns informed the SEC that it would be “unable to operate normally on Friday(March 14).”
Late in the day on March 13, at around 8:00 p.m., we learned that Bear would be filing for bankruptcy protection on March 14. Although we had been monitoring the situation at Bear, this was a surprise. We had not yet been lending to any investment bank.(The Legal Position of the Central Bank: The Case of the Federal Reserve Bank of New York Thomas C. Baxter)
The Fed decided to finance Bear through the weekend.6
On March 14, Derivatives counterparties continued to run from Bear. By that night, liquidity had dwindled to a mere $2 billion7.
Despite the receipt by Bear Stearns of Federal Reserve funding, Bear Stearns worsened and March 16, Bear Stearns accepted an offer to merge with JPMC.
That's the Bear Stearns story. I'll explain in detail next week how this merger came about.8 9
Engin YILMAZ
References
https://en.wikipedia.org/wiki/Bear_Stearns
https://fcic-static.law.stanford.edu/cdn_media/fcic-docs/0000-00-00%20AIMA%92s%20Illustrative%20Questionnaire%20for%20Due%20Diligence%20of%20Bear%20Stearns%20High%20Grade%20Structured%20Credit%20Strategies%20Fund.pdf
https://ypfsresourcelibrary.blob.core.windows.net/fcic/fcic-docs/0000-00-00%20Bear%20Stearns%20High%20Grade%20Structured%20Credit%20Strategies%20Presentation.pdf
https://www.sec.gov/files/litigation/complaints/2008/comp20625.pdf
https://fraser.stlouisfed.org/title/bankruptcy-filing-4972
https://www.federalreserve.gov/regreform/reform-bearstearns.htm
https://www.sec.gov/news/press/2008/2008-48.htm
Crisis Compounded by Constraint: How Regulatory Inadequacies Impaired the Fed's Bailout of Bear Stearns Note, Bryan J. Orticelli
The Legal Position of the Central Bank: The Case of the Federal Reserve Bank of New York Thomas C. Baxter, Jr. Jr.