What Was Bear Stearns?:
Bear Stearns was founded in 1923, and survived the Great Depression to become one of the world's largest investment banks. In 2006, it had over $2 billion in profits from $9 billion in revenues, and over 13,000 employees worldwide. Its businesses included the gamut of financial services, most of which were profitable. However, its drive for profits caused it to go into the hedge fund business, which caused its demise. (Source: Bear Stearns 2006 Annual Report)
Bear Stearns Goes Bankrupt:
Two hedge funds collapsed as a result of investments in subprime mortgage-backed securities and other collateralized debt obligations (CDO's). By December 2007, Bear Stearns announced the first loss in its 80 year history - $854 million for the fourth quarter and a $1.9 billion write-down of its bad mortgage-backed securities. This caused Moody's to downgrade its debt and it could no longer raise enough capital to stay afloat. (Source: NYT, Bear Stearns Co)
The demise started a panic on Wall Street, as banks realized that no one knew where all the bad debt was buried within the portfolios of some of the most respected names in the business. This caused the The Banking Liquidity Crisis, in which banks became unwilling to lend to each other.
Why the Federal Reserve Had to Intevene:
By Friday, March 14, Bear Stearns was worth only $3.5 billion, and entered negotiations to be bought by JP Morgan Chase. However, over the weekend JP Morgan Chase realized Bear Stearns was only worth $236 million - 1/5 the value of its headquarters building. In effect, the company was worthless.
However, thanks to its over-leveraged position, the value of its outstanding trades was $10 trillion. Therefore, JP Morgan Chase needed a $30 billion loan guarantee from the Fed before it would agree to the deal. (Source: The Economist, JP Morgan Chase takes over stricken Bear Stearns, 3/18/08; Mish's Global Economic Trend Analysis, Fed Fails to Halt Debt Meltdown, 3/18/08)
As a result, the Federal Reserve held the first emergency weekend meeting in 30 years to try and save the deal. Without Fed intervention, the failure of Bear Stearns could have spread to other over-leveraged investment banks, like Merrill Lynch, Lehman and Citigroup.
