Legal Commentary

The Bear Stearns lesson

By Tom Kirkendall

Today brought the final installment of Kate Kelly's extraordinary three-part W$J series on the fall of Bear Stearns. My goodness, was Kelly a fly on the wall over at Bear's office during all of this? Although all three installments of the series are excellent, Kelly's most insightful observation of the series comes from the second installment:

It was the beginning of a frantic 72 hours that would bring the Wall Street firm to its knees and threaten the stability of the global financial system.  .  .  . The brokerage's sudden fall was a stark reminder of the fragility and ferocity of a financial system built to a remarkable degree on trust. Billions of dollars in securities are traded each day with nothing more than an implicit agreement that trading partners will pay up when asked. When investors became concerned that Bear Stearns wouldn't be able to settle its trades with clients, that confidence evaporated in a flash. Trading partners, eager to avoid losses, began to disappear almost as quickly. That further fueled rumors of trouble. Some partners, spotting a chance to profit, made bets against Bear Stearns, helping accelerate its demise.  .  .  .

Even after the Bear Stearns lesson, our understanding of the pesky trust-based business model is still not what it should be. Improving the investing public's understanding of how best to hedge the risk of investing in trust-based businesses is a far more productive response to Bear Stearns-type business failures than this. 

Full post as published by Houston's Clear Thinkers on May 30, 2008 (boomark / email).