Bear Stearns Case Study: The beginning

of the Name crisis

1 min read
20 December 2007: BS records 4th quarter loss, writes down mortgage assets of $1.9
billion. Sued by Barclays for misleading hedge fund performance

28 December 2007: Employees sell BS stock worth $ 20 million

Early January 2008: CEO James Cayne resigns. Moody’s downgrade of MBS
tranches issued by BS

Mid-January 2008: Over 20% fall in BS share price

7 March 2008: Shares of Carlyle Capital Corporation (CCC), to which BS has

significant exposure, suspended because of margin calls and defaults notices by
lenders. Triggers concerns regarding liquidity

10 March 2008: BS Press Release to reassure investors that liquidity concerns are
false. Rumors of loss of confidence and cancellation of credit facilities.

11 March 2008: CFO says rumors false. Goldman Sachs says it will not stand in for it
clients if they wished to undertake derivative deals with BS

12 March 2008: CEO says no liquidity crisis on CNBC and that quarter will show
profit. Banks withdraw credit lines and clients stop using BS brokerage

13 March 2008: CCC hedge fund collapses. BS share price falls 17%. CEO
announces all is well. Liquidity falls from $17 billion to $2 billion.
13 March 2008: CEO approaches JP Morgan for rescue package and clients to
express confidence in BS publicly. Latter declined.

14 March 2008: BS says JP Morgan with Fed Reserve has agreed to provide funding.
Share price falls 40%. S&P and Moody’s cut BS ratings

16 March 2008: JP Morgan announces that they have acquired BS for $2 per share
On 14th June 2007 Bears Stearns reported a decline of 10% in profits for the second quarter over
the previous quarter’s profits to $486 million. On 18th June 2007 Merrill Lynch seized the $850
million of the collateral comprising of thinly traded CDOs, of one of hedge funds that were
heavily invested in subprime mortgages due to increased margin calls and failure of payment of
debt obligations by the hedge fund because of the depressed value and illiquid market of its
assets. When Merrill Lynch went to liquidate these derivates, they were only able to do so
fractionally (only $100 million worth could be auctioned) and that too at marked-down values
because of the lack of market liquidity for these instruments.

This led to Bear Stearns pledging $3.2 billion in secured loans to bail out one of its subprime
hedge funds, Bear Stearns High-Grade Structured Credit Fund on 22 June 2007 together with
negotiating loans with other banks against its collateral to bail out another hedge fund, Bear
Stearns High-Grade Structured Credit Enhanced Leveraged Fund. This was done in order to
counter what the failure of these hedge funds would do to its reputation as well as how the asset
values could be impacted if the collateral continued to be sold in the illiquid and depressed
market.

On 17th July 2007 as a result of the continually declining value of the subprime mortgages and
the resulting fall is asset values of the derivative securities, Bear Stearns revealed to its clients
that the hedge funds had lost all or almost all of their value. Investors in the two hedge funds
sued Bear Stearns for the collapse of the funds and sought arbitration claims saying that the bank
had misled them about its exposure to these funds. In response the funds filed for bankruptcy
protection on 1st August 2007 and the company froze the assets of a third fund. The amount lost
was around $1.6 billion.

The co-president and the person responsible for the management of these funds, Warren Spector,
who was much touted to succeed Bear Stearns chief executive James Cayne resigned on
5th August 2007 following the collapse of the funds. On August 6th, the bank reassured clients by
letter that the company was financially sound with the necessary experience and expertise to deal
with challenging markets. On 17th August 2007 Bear Stearns cut 240 jobs from the loan
origination units of the bank.

On 20th September 2007, the bank reported a drop of 61% in profits for the quarter to $171
million. In early October 2007 Bear Stearns CEO and president informed the public that most of
its businesses were beginning to recover. It cut an additional 300 jobs. On 22 October 2007, it
received an injection into its funding when it entered a share-swap deal with CITIC, China’s
largest state-owned securities firm. Under the deal CITIC would pay Bear Stearns $1 billion for a
6% share in it with an option to buy a further 3.9% of the investment bank and in return Bear
Stearns would eventually pay a similar amount for a 2% share in CITIC.

On November 14 2007 its CFO Molinaro reported that it would write down its assets and book a
4th quarter loss. This resulted in a ratings downgraded by S&P 500 from A+ to A stating that the
outlook was negative. End November 2007 it released news that it planned to further reduce its
global workforce by 4% or 650 jobs. Early December 2007 Joe Lewis an influential shareholder
increased his share in Bear Stearns on grounds that he believed the banks shares to be
undervalued and that the bank was on its way to recovery.

The bank registered its first loss in its 85-year history in the 4th quarter of 2007 amounting to
$854 million due to a write down of $1.9 billion of the value of its holdings of mortgage assets.
Barclays bank sued Bear Stearns for allegedly misleading them about the performance of the two
collapsed hedge funds which were pledged as collateral against a $400 million loan granted to
Bear’s asset management division.

Top employees of the company said they’d skip their bonuses but they including the CEO Cayne
sold their company’s stock together worth over $20 million in December 2007. James Cayne
resigned as CEO in early January 2008 though remained as the bank’s non-executive chairman
with a remaining 5% share in the bank. Moody’s Investors Service downgraded the ratings of 46
tranches issued by Bear Stearns in 2006 (including 24 to junk status) and an additional 11
tranches of Alt-A deals issued in 2007 were also place under review for possible down based on
higher than expected rates of default and foreclosure.

Due to the news of the quarter’s losses, sales of stock by the top employees and downgrades of
its derivative securities including a more general concern that the US economy would slip into a
recession, Bears Stearns share price fell drastically by more than 20%. As a result of this fall it
was reported in mid-February 2008 that CITIC the Chinese state owned lender had begun to
renegotiate their share-swap agreement with the bank.

On March 7 2008, the Carlyle Capital Corporation, a hedge fund had suffered because of the
subprime crisis had received substantial margin calls and default notices from its lenders. Due to
this it had its shares suspended in Amsterdam. As the Carlyle Group was founded by Bear
Stearns which also had a 15% shareholding in the Carlyle Capital Corporation many investors
and clients viewed Bear Stearns as been heavily exposed to it. This fueled concerns regarding
whether or not the investment bank had sufficient cash/ funds to do business. The cost of
insuring $10 million worth of Bear Stearns credit default swap debt went from $ 350,000 to over
$ 1 million. Borrowing costs for Bear Stearns began to rise sharply.
In response to this Bear issued a press release on 10th March 2008 stating that there were no
grounds for any rumors regarding their lack of liquidity saying that it has $17 billion in cash.
However, the fact that a public announcement has been made was read as a signal by many Wall
Street experts, that the bank was in trouble. There were also reports that a major bank had
refused to lend to Bear via a repo transaction a short term loan of $2 billion and therefore rumors
persisted that the bank was losing confidence among its creditors.

On 11th March Bear continued to reassure it customers and investors that nothing was wrong with
its liquidity position with CFO Molinaro announcing on CNBC that the rumors were false.
However on the same day Goldman Sach’s credit derivative group told its clients via email that it
would no longer step in on their behalf to executive derivative deals with Bear Stearns. Other
banks too refused to provide further credit protection against Bear Stearns debt.

On 12th March 2008 the CEO Alan Schwartz made gave a televised assurance to investors that
there was no liquidity crisis and that the first quarter of 2008 would likely turn a profit for the
bank. However when the news regarding the Gold Sach’s email leaked into the market many
more hedge funds and clients began withdrawing their funds from the bank. Banks were backing
out of providing credit and Bear Stearns credit lines were dramatically reduced. Hedge funds,
mutual funds and capital management companies stopped using Bear Stearns’ brokerage service
for executing their trades.

On 13th March 2008 the Carlyle Capital Corporation hedge fund collapsed which resulted in a
fall in the Bear Stearns share price of 17%. The CEO publicly continued to maintain that all was
well and that the collapse of the hedge fund and subsequent fall in share value had not weakened
the bank’s balance sheet. However liquidity had now dropped to $2 billion. Schwartz approached
JP Morgan to negotiate a rescue package. In the meantime the bank contacted a major client to
encourage them to publicly express their confidence in Bear. The client declined.

On 14th March 2008 Bear Stearns confirmed the news that they had secured short term funding
amounting to $30 billion from JP Morgan, the clearing agent for its collateral, in order to
stabilize its position, strengthen its liquidity and meet the demands of its lenders. The collateral
pledged would be backed by the Federal Reserve Bank of New York against the risk of its
decline. However this funding was not sufficient to quell fears by investors regarding Bear
Stearns financial stability and share prices fell by more than 40% on the news. S&P and
Moody’s slashed ratings on the bank to just above junk status with a warning that further
downgrades were possible.
On 16th March 2008 JP Morgan announced that it had acquired Bear Stearns for $2 per share. By
March 24th 2008 the offer was raised to $10 per share in order to appease Bear Stearns
shareholders. This was eventually approved by them.