Corporate Governance

Bear Stearns, Corporate Governance, and the Capital Markets: Overvew (Part 1)

By J. Robert Brown

We have been watching the unraveling of the capital markets, the efforts to rescue Bear Stearns, and the efforts of complete flip by the Secretary of Treasury on the merits of regulation.  We begin a multi-part series on the transaction.  In particular, we will ask about the proper direction of regulation, with a novel response, and the role of the board of directors in the debacle.

We start with a short overview of what happened.  For that, we provide a succinct explanation from the Commission:

• In accordance with customary industry practice, Bear Stearns relied day-to-day on its ability to obtain short-term financing through borrowing on a secured basis. Although Bear Stearns continued to have high quality collateral to provide as security for borrowings, as concerns grew late in the week, market counterparties became less willing to enter into collateralized funding arrangements with Bear Stearns.
• Late Monday, March 10, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. Bear Stearns' counterparties became concerned, and a crisis of confidence occurred late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms.
• This unwillingness to fund on a secured basis placed stress on the liquidity of the firm. On Tuesday, March 11, the holding company liquidity pool declined from $18.1 billion to $11.5 billion. On Wednesday, March 12, Bear Stearns' liquidity pool actually increased by $900 million to a total of $12.4 billion. On Thursday, March 13, however, Bear Stearns' liquidity pool fell sharply, and continued to fall on Friday.

An old fashioned liquidity crisis.  But in fact things are far more complicated.  For one thing, Bear Stearns continued to suffer the consequences of two hedge funds that failed in the summer of 2007.  There was, as a result, a lack of trust.  Moreover, even with the Federal Reserve Board opening the cash spigot, clients were fleeing the company, no longer willing to keep their business with Bear Stearns. 

It was about confidence, trust and integrity.  As the Washington Post noted:  "The Bear Stearns debacle has revealed a central reality of Wall Street: Investment firms live and die on confidence."   By engineering the takeover by JP Morgan, the Fed essentially put the Morgan name behind the Bear Stearns business activity, returning confidence. 

We will, over the next several posts, examine this fiasco in greater detail.  In particular, we will examine the role of the board of directors and proposed regulatory reform arising from this matter. 

Full post as published by The Race to the Bottom on March 25, 2008 (boomark / email).