Corporate & Securities Law

More than any other business, financial institutions are vulnerable to crises of confidence. Former investment bank Bear Stearns had a substantial prime brokerage unit. In simple terms, this means that other financial institutions - primarily hedge funds - essentially used Bear Stearns like you and I would use our local bank. Bear was custodian of billions of dollars for these prime brokerage clients. And it was these customers who were behind the much talked about "run on the bank" that ate up Bear's liquidity and forced it into the arms of JP Morgan.

Now, when doubts arise about the viability of a major financial institution like Bear Stearns, there is almost always a legitimate and serious problem (or problems) at the heart of the matter.  Any issue substantial enough to jeopardize confidence in an investment bank by investors, creditors, counter-parties, and customers is, by definition, serious. In March 2008, that is the situation Bear Stearns faced.

At any financial institution, it is the CEO's job - the CEO's responsibility - to prevent serious problems.  By serious, I mean the kind of problems that can undermine confidence in your company.  This is just the fact of the matter.  And, like it or not Mr. Cayne and Mr. Schwartz, the responsibility is warranted.  Wall Street Chief Executives regularly earn (or earned) eight figure bonuses. Its a bear, guys, but with that kind of pay comes some serious accountability.   

Yes, there was a run on Bear Stearns.  And it happened because practically everyone lost confidence in the former powerhouse investment bank.  However, the crisis of confidence grew out of serious problems that Bear Stearns created.  The Bear's wounds were self-inflicted.  

Some examples?  Certainly.  

For starters, the company had a distinctly undiverse business structure. Bear Stearns was far too dependent on its fixed income business and lacked sufficient fallback revenues after the market for mortgage-backed securities (MBS) collapsed. 

Lacking reliable replacement streams of revenue was bad enough, but Bear Stearns had also overloaded its securites portfolio with, you guessed it, toxic MBS. Bear Stearns drank its own cool-aide, and creditors eventually decided that the worthless MBS were not acceptable collateral. 

To complete the trifecta, Bear Stearns was buried beneath a mountain of debt.  Bear was the most leveraged firm on Wall Street, at close to 35:1.  In other words, the firm borrowed money to finance more than 95% of its investment activity. Bear Stearns also depended on borrowing more than $50 billion each day in the overnight repo market to fund daily operating expenses. There was no question that the investment bank was in trouble, as it had been since at least August 2007.

There was, by the way, a deepening credit crisis already ongoing by the week of March 10, 2008. Carlyle Capital's large MBS hedge fund had just collapsed, banks were writing down the value of Alt-A mortgage-backed securities and CDOs left and right (Bear held a lot of Alt-A MBS) and, on March 10, a major credit rating agency downgraded a CDO stocked with Alt-A MBS that Bear Stearns had securitized and sold.

In sum, there were innumerable reasons for the financial universe to lose confidence in Bear Stearns. There was no act of God, no perfect storm, no (as Jimmy Cayne has said) hurricane.  There was a poorly run investment bank that took tremendous risks and ultimately got burned. Bear's customers were right to pull their money. 

Bear Stearns was steaming through icy waters and hit an iceberg. Its customers had no responsibility to stay on board to see if the foundering boat could be salvaged.  The institutions that pulled their money from Bear Stearns did the responsible thing for their own clients. They couldn't risk the possibility that the millions of dollars and other assets they had on deposit with Bear Stearns would go down with the ship.