Bear Stearns; Founded in 1923 and employing some 15,500 people worldwide, Bear Stearns was one of the “big five” Wall Street investment banks. In 2005-2007, Bear Stearns was recognized as the “Most Admired” securities firm in Fortune magazine’s. The second largest US underwriter of mortgage bonds, With the de facto collapse of Bear Stearns, however, the housing and credit market collapse has claimed one of the titans of Wall Street.
Credit Bubble
The underlying problem is the vast credit bubble that was inflated on the basis of reckless and intrinsically unviable home loans and other forms of speculation, including leveraged buyouts and a vast expansion in unregulated credit markets that delivered unsustainably high returns on investment. The immense fortunes amassed by the uppermost echelons of the US population on the basis of such parasitic financial operations have created, as their consequence, a social and economic disaster of historical proportions, threatening tens of millions of Americans, and hundreds of millions more people around the world, with pauperization.
How it started for Bear Stearns ..
Last July, the collapse of two Bear Stearns hedge funds as a result of the bursting of the US housing bubble sparked a crisis of confidence in the credit system that has gathered steam and expanded in scope to threaten the viability of some of the biggest banks and financial institutions .
The explosive growth of the derivatives market, in which Bear Stearns and other brokers and banks are major participants, has heightened anxiety about so-called counterparty risk( fear that the bank on the other side of a trade will not be able to cover positions if need be). The CDS (credit default swaps) market, which has grown to a notional value of $US45 trillion, has yet to be tested by a major disruption. There has been a potential CDS counterparty problem where we have more buyers than qualified sellers. With Bear having such a large CDS counterparty position, one can't expect to have that $US45 trillion market come apart. Since late Thursday(13th March 2008), anyone looking to unwind a credit derivative position with Bear Stearns won't be able to, since no one wants to face the firm as a counterparty
Speculation about Bear Stearns problems gained momentum amid turmoil in the agency mortgage bond market on the back of the collapse of hedge fund Carlyle Capital Corporation in which Bear Stearns had a major exposure. Carlyle Capital Corporation, a $22 billion publicly traded investment fund controlled by the Carlyle Group, had beenone of the profitable and well-connected private equity firms in the US. CCC has been facing margin pressure and was unable to finance the trades. Once you have a run on the bank you are in a death spiral and your assets become worthless. The stock which once traded at 170$ levels had corrected to below 30$ and now its been valued around 2$,.
At 30$ the stock is 60% below its book value of 80$. Re-winding back 8-years ago when ex-CEO Mr. James Cayne’s hinted — that he would only sell the firm for four times its book value — was even then a flight of financial fancy. Wall Street investment banks rarely command such a premium to their book value, given the inherent and unpredictable risks of their business. And this has been proven beyond doubt in the present days frenzy.For now, the prospect of a new wave of consolidation in the financial services industry seems remote. That is because would-be acquirers and everyday investors alike have lost faith in the values that Wall Street firms are placing on their own assets. Credit ratings agencies Standard & Poor's and Fitch Ratings both slashed Bear's credit ratings to triple-B, near the bottom of the investment-grade ladder before junk, and Moody's Investors Service cut its rating to Baa1.
Question will be raised on the high leverage such companies have, Bear Sterns is among a highly leveraged company with 33:1 ratio in terms of leverage of Debt to equity. At such cruical moment Capital structure of the firm itself is to be challenged and cost of assets it has.
The Fed's Action of Friday (http://wsws.org/)
The Federal Reserve Board on Friday took emergency action to prevent the collapse of Bear Stearns, the fifth largest US investment bank and one of the world’s largest finance and brokerage houses.
Invoking a little-used provision added to the Federal Reserve Act in 1932, at the height of the Great Depression, the US central bank agreed to allow the Federal Reserve Bank of New York to insure an infusion of credit to Bear Stearns by JP Morgan Chase. Under the terms of the “secured loan facility,” to extend for up to 28 days, the risk of a default by Bear Stearns will be borne by the Federal Reserve Bank of New York, not JP Morgan Chase. The latter will serve essentially as a conduit for the cash provided by the US central bank.
This mechanism was used because only commercial banks, so-called depository institutions, can borrow directly from the Fed’s discount window. Bear Stearns is not a depository bank, and hence the Fed was obliged to invoke a provision of the 1932 amendment to the Federal Reserve Act that applies when “unusual and exigent circumstances exist and the borrower is unable to secure adequate credit accommodations from other sources.”
Who's next ??
Today morning when the US markets opened, all the brokerages were sharply lower, with Goldman Sachs down 6%, Morgan Stanley off 8% and Merrill Lynch down 9%. Indeed, investors are taking a grim view of the prospects for other investment banks like Lehman Brothers and Merrill Lynch. Next to Bear Stears, Lehman is the smallest and least diversified brokerage firm on Wall Street, so there are worries that it will be the next firm to come under attack as firms that trade with Lehman pull back in a bid to protect themselves.
Citigroup, one of the US's largest banks, is now trading below its book value. Lehman Brothers, at $39, is trading just below the book value it reported at the end of last year. This year, Bear’s stock is down 65 percent and Lehman’s has sunk 40 percent.
Indicative of the broader reverberations from the Bear Stearns collapse, the share price of Ambac Financial Group, the world’s second-largest bond insurer, fell 93%, on widespread fears that the company will not have sufficient capital to meet claims from its creditors.
And analysts are speculating that Lehman may not play a big enough role in the markets to justify a Fed-backed bailout like the one at Bear Stearns. And while Bear’s peers on Wall Street are not yet in such dire shape, they have surely accepted the reality of leaner times and lower valuations in the months to come.
Very true that this has been proven time again since the Great American Depresion and Oil Shake that the fact is thatBanks and brokerages are a house of cards built on the confidence of clients, creditors and counterparties; If one where to take chunks out of that confidence, things can go awry pretty quickly, pack comes crashing down.
Impact on India
The timing of the move made its urgency clear: If Bear could have held out until March 27, it could have borrowed directly from the Fed itself under a new program announced.
The maximum size of the loan is not predetermined, but is limited by how much collateral Bear Stearns can provide to satisfy the Fed’s requirements. The loan by no means assures Bear Stearns’s survival. More likely, it was granted in the hope that it would buy time for a more orderly disposition of the firm’s fate and head off a panic response by bankers and investors to its demise.
The impact on hedge funds dealing with the bank could be that those that rely on the bank to finance trading and hold securities would be stranded and could be looking to other banks for trading and financing. Bear Sterns has interests in more than 15 companies--from real estate, infrastructure, energy to capital goods. The investment bank has maximum exposure in RPG Transmission at 8.93 per cent, trading in the counter is suspended at the moment and on the lower side, 1.06 per cent in Hindustan Construction Company. Bear Stearn's has already sold off close to 900 (250 on Friday & 650 on Monday) crores of equity in the Indian markets, and in situation where the markets have so little cushioning to offer, the companies in which Bear Stearns had its interests in would go down along with its sell-off.
Bear Stearns forced to sell off assets at fire-sale prices to raise cash needed to meet creditors’ demands, the value of untold billions in assets held by other financial institutions would drop, leading to more margin calls from creditors, further institutional collapses, more panic selling of debt and securities—a vicious spiral to the bottom with the potential of a breakdown in the entire capitalist financial system. Brokers in India are already feeling the pain; The BSE benchmark Index Sensex witnessed its 2nd largest fall in its history recording a fall of 951 points due to the sell off. Investor sentiment (mine included) has been beaten down heavily and this will continue untill a few more institutions fall off.
Companies like India Bulls, Motilal Oswal, ShareKhan have had deep corrections with dropping trading volumes and huge market risk, this happend to be just a prelude of what will hit out markets.
All these developments and the impact of the same in terms of market reaction locally all prove that the So-called De-coupling is far from reality for the Indian markets as we continue to out perform in terms of fall we exhibit in comparision to markets globally.
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