Bear and Stern Case Analysis

Group 2

Akash Lal O MS21A001

Saurabh K MS21A059

COMPANY OVERVIEW:

Bear Stearns was founded by Joseph Bear, Robert Stearns and Harold Mayer in 1923.
Its key operations included trading of government securities to last through the Great
Depression.

Grew from seven to 75 personnel and increased in size by 1933. acquiring Stein,
Brennan from Chicago.

In 1985, the business went public, expanded its business, and evolved into a full-service
investment bank. In 1993, Cadence succeeded Greenberg as CEO.

KEY ISSUES:

● Company survived the great depression, savings, loan crisis and dot-com crisis
and was successful.
● However, two of Bear's hedge funds collapsed as a result of the subprime
mortgage crisis, and the company lost the trust of its investors.
● It was not able to retain its potential investors and infuse capital due to its highly
leveraged status, unsuccessful leadership and coordination issues which lec the
company losing its value from $170 per share to $2 per share.

1) What role did Bear’s culture play in its positioning Vis a Vis its competitors? What role
might that culture played in its demise?

● The business presented itself as "an unconventional or independent-minded

person," or a Maverick.
● Bear had a ruthless renegade mentality, and the business was mainly focused on
trading bonds. Trading bonds was highly dangerous because they were market-
sensitive and might either try to be lucrative or result in significant losses for the
corporation.Lewis(CEO) reinforced the bond trading culture and ran the company
almost as a holding company of independent profit centers.
● Bear set diverse workforce culture and focussed on hiring candidates who were
PSD: poor, Smart and has a deep desire to become rich over those who had
MBA degree. They had a diverse mix of employees.
 ● When LTCM was struggling, the corporation supported it; otherwise, the
company might have survived itself during the bailout in 2008
● The business failed in 2008 as a result of its independent attitude. Their unique
performance on the market led to many problems with the other market
participants, which eventually damaged the company's standing among its
stakeholders.
● The organization hired its staff based on each person's unique qualities, rather
than their academic credentials, of being driven and taking the initiative. This
could have been a critical factor as these candidates would have limited
exposure before taking up bigger responsibilities.

2) How did bear’s potential collapse differ from that of LTCM in the eyes of the Federal
Reserve?

LTCM:

● In the case of LTCM, the Fed tried to resolve the issue in the name of preserving
market integrity.
● As LTCM had thousands of derivatives involving a number of investment firms
around the globe, a collapse on part of LTCM would initiate a wider collapse in
the international securities market, they stepped in to establish order.
● The Fed played an advisory role in this bailout and convinced other banks to help
LTCM in the name of market stability.

BEAR:

● In this instance, the Fed was crucial to the bailout.

● The top executives at Feb engaged in a high-stakes game of poker without
● adopting the right position. The Federal Reserve does not desire any
unprecedented government involvement in
● The bailout and persuaded JP Morgan to purchase Bear Stern
● The Fed representatives reduced JP Morgan's bidding in an effort to deter the
moral hazard that would result from the Fed intervening to prevent hazardous
behavior by investment banks. They decreased their first $4 offer and advised JP
Morgan to make a $2 offer instead.

3) What could Bear have done differently to avoid its fate:

In the early 2000s?; During the summer of 2007 -; During the week of March 10, 2008

In the early 2000s:

● Bear might have assisted LTCM in receiving the bailout. It might have aided them
in maintaining their reputation and in avoiding a similar outcome to what
 happened to JP Morgan
● Bears ignored the recommendations made by Ackermann et al in the early
2000s, who emphasized the danger that hedge funds can have despite the better
returns and urged greater diversification with lower volatility. They could have
distributed their risk more widely.
● The USA's industries, with the collapse of the housing market, Cioffi lost money.
He obtained further funds with 100x leverage and increased his bets on the funds
rather than cutting his losses with the prior 35x leverage.

During the summer of 2007:

● The Cioffi’s fund were worthless which forced them to file for bankruptcy
protection. In an intention to calm the stakeholders, Cayne wanted to depict an
image outside that they were strong on the financial ground.
● Cayne could have handled the situation with respect to the media in a better way.
He could have acted enthusiastically in the question and answer that he was
involved in, instead of depicting as if he was not interested in the position of the
company.

During the week of March 10, 2008:

● Immediately following Moody's downgrading, the corporation might have issued a

statement outlining the actual situation while also attempting to reassure the
stakeholders. This would have helped the general public develop trust in the
organization.
● They wouldn't have needed to appear on CNBC where they were peppered with
questions that eventually damaged the company's reputation if they had provided
an honest option.

4) Who stood to benefit from its implosion?

Answer:

1. The competitors

The competitors of Bear and Sterns stood to benefit from the implosion since they get
larger market share.

2. JP Morgan Chase

They offered to buy the company for $4-5 per share. They later reduced it to $2 per share
due to the influence of Fed’s representatives.

3. The hedge funds, that is an internal department of Bear’s bank.

5) Is market perception of liquidity more important for an investment bank than for a
traditional manufacturing business? Why?

Answer:

Yes, the market perception of liquidity for an investment bank is very important when
compared to a traditional manufacturing firm.

It takes longer for traditional companies to feel the effects of liquidity, when compared to
a traditional manufacturing business. However, the manufacturing business almost has
fixed assets. In accounting, as we know, Manufacturing Cost is recorded in Fixed cost
because the manufacturing business always makes a good through a process involving
raw materials, and components.

Most of the liabilities of the investment banks are in the short term, while their assets
are long-term. It is very important for the banks to hold liquid assets for them to meet
the mismatch in their assets and liabilities.

If the market perceives an illiquid situation, it will further worsen their liquidity position
with various stakeholders, demanding their money.

In the case of LTCM’s crisis and Cioffi’s funds, their liquidity position was the major
reason for bail-out and bankruptcy.

6) How could Bear have addressed perceptions of illiquidity? Could it have stopped the run
on the bank? If so, how?

Answer:

After the SEC investigation, the company had $21 billion in cash reserves and did not
have any liquidity issues. But it did not make this known to the public market, which
otherwise would have increased market confidence.

After Cioffi’s hedge fund failure, Bear could have reduced their massive mortgage
inventory and the bonds that backed them.

They could have fully accepted their illiquidity issues rather than denying them
outrightly, thinking that the worst would be behind them if they did. It could have
potentially stopped the run on the bank because it wouldn’t have startled investors so
much when they found out that Bear Stearns was in effect lying about their liquidity.
7) Did Bear’s failure undermine the viability of so-called “Pure-play” investment banks?

Answer:

Pure play is a business that invests all its resources on one single line of business. This
could yield greater returns to the company in a favorable situation, but puts the business
at high risk when the situation is unfavorable.

Bears basically proved that having over-leveraged positions in certain industries (not
being diversified as an investment bank) led to Bear’s demise and ultimate failure,
which definitely undermined the viability of other “pure-play” investment banks.

Bear was initially focused solely on the bond market. With favorable market conditions,
they saw growth. Later they went into CDO and mortgage obligations and later saw
success.

In the case of businesses that are characterized by high levels of risk, pure play is a
risky strategy.

However, in the case of a company like Bear operating in a volatile landscape, pure-
play is not an ideal strategy to follow. It would be ideal for an investment company to
diversify its portfolio.

8)What role should the Fed play in maintaining order in the world securities market?

Answer:

The role of the Federal Reserve should be restricted to that of supervision and
regulations such that they are not put in situations involving moral hazards like that of
Bear Stearns.

The involvement of the Fed in situations like this in the name of maintaining stability
might encourage other companies to act carelessly in hope that the Fed might bail them
out.

The markets may also be impacted, and investor confidence may decline, if the Fed
stays out of key situations.

In this case, the Fed should have proper mechanisms in place that helps them identify
such situations beforehand and act on them before in the initial stages itself.