For the rest of the year, Lehman Brothers attempted to unwind its positions by selling stock and decreasing leverage. However, investor confidence continued to bleed out. Had those investors kept those shares, they would have recouped their losses eleven years later, according to the Wall Street Journal.
Some economists have attributed the subprime mortgage crisis to financial deregulation, particularly the repeal of parts of the Glass-Steagall Act. This repeal removed the legal barriers between commercial and investment banking, allowing banks like Bear Stearns to issue and underwrite securities. These securities would ultimately become a major catalyst for the financial collapse. While there are no clear winners from the Bear Stearns collapse, stockholders would have suffered arguably greater losses had the bank gone bankrupt.
Although the financial crisis caused a public outcry, there was no reckoning for the bankers who were blamed for the crisis. Two managers at Bear Stearns hedge funds were arrested for misleading investors, but they were found not guilty. The only successful prosecution was of Kareem Serageldin, a Credit Suisse executive who was convicted of mismarking bond prices to hide the bank's losses. Formerly one of the largest investment banks on Wall Street, the collapse of Bear Stearns is now regarded as a cautionary tale against corporate greed and the whims of the free market.
In the housing bubble of the early s, Bear Stearns leaned heavily into mortgage-backed securities, vastly underestimating the risks of the subprime housing market. When the housing market collapsed and borrowers began to default, the value of those securities plummeted. Since the purchase was supported by the Federal Reserve, the acquisition raised ethical questions about corporate bailouts and the government's role in a market economy.
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If the liquidation mandate were strictly applied, Title II would never be used. Given the potential severity of the consequences, regulators would be strongly tempted to bail the institution out instead. The FDIC has devised an alternative resolution strategy, however, that would recapitalize rather than shut down the troubled institution. More recently, lawmakers have proposed legislation that would facilitate analogous transfers in bankruptcy by, among other things, authorizing transfers effected on short notice and imposing a temporary stay on derivatives.
SPOE is quite elegant on paper—indeed, it converted me from a strong critic of Title II to a cautious supporter—but it is impossible to know whether it would in fact work in practice, either under Title II or in its bankruptcy incarnation.
Skeptics worry, among other things, that creditors would run, despite the plan to quickly create a fully solvent bridge institution. This would provide two lines of defense, bankruptcy as the first resort and Title II as the backup. In addition to the legislative changes since , the regulators themselves have adjusted to the post-crisis world.
In , the Fed and Treasury seem to have had very few bankruptcy experts in their midst. This may have been one reason bankruptcy was not more seriously considered with Bear Stearns. A decade later, there seems to be much more bankruptcy expertise within the ranks of the regulators. Given all these changes, the misperception of Lehman may seem to be solely of historical interest, and of little relevance for current financial markets.
In reality, however, the misperception still matters a great deal. First, the conventional wisdom could chill enthusiasm for enacting the bankruptcy-for-banks legislation currently pending in Congress. Lawmakers and others who are skeptical about bankruptcy are likely to view bankruptcy amendments through the lens of that skepticism.
This would be unfortunate. As I have argued on this site previously, 19 the proposed legislation would significantly improve the effectiveness of bankruptcy by facilitating SPOE-style transactions. Under SPOE, shareholders would not be the only constituency that would bear losses. Bondholders and other holders of longterm debt would too, and they can be expected to argue vehemently that SPOE will unleash chaos if it is implemented, just as according to them bankruptcy would.
The shadow of Lehman could reinforce this reasoning. It could discourage regulators from invoking Title II, or could encourage them to delay intervention too long. If regulators and others do not believe bankruptcy can work, they may slack off in their preparations for its use. They may not oversee the living will process and stress tests as vigorously, and incorporate bankruptcy as fully, if they do not believe bankruptcy will actually be an option if a large financial institution falls into distress.
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Mar 12, Finance. This week March 14, a Friday in marks the tenth anniversary of the first Federal Reserve System emergency loan to or for the benefit of Bear Stearns and Company. The parentheses are needed because that first loan technically went to JPMorgan Chase, which acted as a conduit channeling Federal Reserve credit to Bear Stearns.
Estimates at the time indicated that Bear Stearns had leveraged its capital up to 35 times going into its final crisis. That is, the firm had no more than a 3 percent risk-absorption cushion during a period of increased market volatility. By Thursday night, March 13, , Bear Stearns no longer could cover its liabilities as they became due at par value, which traditionally were established tests for the viability of any securities firm.
Financial market practitioners usually divide into two camps: First, those who believe, somewhat cynically, that there is no difference between a and b —blame-shifting and loss avoidance are typical; and second, those who believe that, however financial markets work, finance always should be held to traditional standards of good faith, fair dealing, and market-value solvency.
The Bear Stearns episode was a watershed moment in the unwinding of the financial crisis, whose main blows were reserved for September of that year. Too much financial, regulatory, and moral rot had been allowed to build up in the framework of financial markets after , in an almost unbroken chain of smaller excesses leading to greater excesses, for one to say that, if the Bear Stearns failure been handled differently, then the fall crisis could have been avoided or at least rendered milder.
But it was clear at the time and became luminously clear afterward that the efforts to rescue Bear Stearns and its creditors paved the road to mishandling both that fall crisis and the subsequent recovery efforts. Emergency lending to large financial institutions, whose continued existence may depend on maintaining public confidence, usually carries with it the elements of secrecy and deniability illustrated by the quotation from Macbeth above.
Preserving plausible deniability is one of the supreme goods pursued in Washington whenever breaches of good faith, fair dealing, and market-value solvency are discovered.
So it is with emergency lending in America. That eligible collateral usually was understood to be either United States government securities or financial paper arising from current transactions in commerce. Securities firms like Bear Stearns ordinarily did not hold enough eligible collateral to be of much use in a financial crisis.
To make discount window credit available to securities firms, representatives of the Securities Industry Association, their main lobbying group at the time, arranged for the insertion of a clause in the Federal Deposit Insurance Corporation Improvements Act of FDICIA that replaced the eligibility-for-discount clause regarding collateral in Section 13 3 with a new one allowing the collateral to be anything satisfactory to the Reserve Banks.
That change occurred in the final markup hearing and had not been presented in any hearing or floor debate on the bill. Morgan Chase and Co. But its increasing involvement in the hedge-fund business, particularly with risky mortgage-backed securities, paved the way for it to become one of the earliest casualties of the subprime mortgage crisis that led to the Great Recession.
In the early to mids, as home prices in the United States rose, lenders began giving mortgages to borrowers whose poor credit would otherwise have prohibited them from obtaining a mortgage.
With the housing market booming, Bear Stearns and other investment banks became heavily involved in selling complex securities based on these subprime mortgages, with little regard for how risky they would turn out to be. After peaking in mid, housing prices began to decline rapidly, and many of these subprime borrowers began defaulting on their mortgages. Mortgage originators started feeling the effects of the crisis first: New Century Financial, which specialized in subprime mortgages, declared Chapter 11 bankruptcy in April The following month, the firm revealed that the High-Grade fund and another related hedge fund had lost nearly all of their value due to the steep decline in the subprime mortgage market.
For the fourth quarter of , Bear recorded a loss for the first time in some 80 years, and CEO James Cayne was forced to step down; Alan Schwartz replaced him in January Barely two months later, the collapse of Bear Stearns unfolded swiftly over the course of a few days. In this type of deal, Bear offered bundles of securities to another firm or an investor such as a hedge fund in exchange for cash, which it would then use to finance its operations for a brief period of time.
Schwartz called on J. The Fed agreed to provide an emergency loan, through J. Morgan, of an unspecified amount to keep Bear afloat. By Saturday, J.
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