The Bear Stearns
Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage firm, until its sale to JPMorgan Chase in 2008 during the global financial crisis and
recession. Its main business areas, based on 2006 net revenue
distributions, were capital markets
(equities, fixed income, investment banking; just under 80%), wealth management (under 10%), and
global clearing services
(12%).
Lowenstein states
in his book that Bear Stearns was involved in securitization and issued large
amounts of asset-backed securities,
which in the case of mortgages were pioneered by Lewis Ranieri, "the
father of mortgage securities" (2010).
There are some
major causes that made the Bear Stearns collapse. The rumors about running out
of cash made people loosing confidence. Then, they want their money out which
could cause the rumor to become true. But the securitization of subprime
mortgages, which are called toxic assets, was the main cause of Bear Stearns to
collapse. Bear borrowed too much to invest in these toxic assets and it should
have found more lenders to loan money to Bear.
The moral
hazard issue is again on its work in the financial markets. It is a term that
is the encouragement to take risky or reckless action that arises when your
losses are insured by someone else (Quiggin, 2008). If a company is bailed out,
it may make the same mistakes again and if the company was allowed to fail,
this may create a great systematic risk.
Tim
Geithner learned that Bear had made credit default swap deals worth trillions
of dollars all over Wall Street and around the world. Because Bear Stearns was
so indebted to so many other people, their failure to repay their debts, or pay
their debts, would cause a cascade of other failures, and it was frighteningly
interconnected with other banks in Wall Street. Geithner saw that central
bankers most fear from systemic risk. Bear Stearns, Geithner concluded, was
“too big to fail.” A bankruptcy could undermine confidence in every major Wall
Street firm.
Because of the
issue of moral hazard, Lehman Brothers allowed to fail. Moral hazard concern of
federal government surpassed systematic risk and they decided to not bailout.
But the decision seemed to be wrong in the following days. Systematic risk
become real and none of the banks lend to each other even if they know well the
inter-bank lending is the bedrock of the banking system.
Mortgage crisis
became a general credit crisis with frozen credit markets after the banks had
stopped lending. Investors were shaken by Lehman’s bankruptcy. Commerce in
America was grinding to a halt. The world’s largest insurance company AIG was
down 70%. Geithner
realized that if AIG went down, the consequences would be even worse than
Lehman, so he argued for another bailout. He punished the banks that were
parties in AIG’s toxic deals by making them take a financial hit. He made the
parties have to take a discount on their insurance policy with AIG. As a result, government initiated a
full-scale bailout of the U.S.’s financial system by taking stakes in the
largest banks in U.S.
Lowenstein, R.
(2010). The End Of Wall Street, Penguin, pp.xvii,22
Quiggin,
J. (2008). Moral Hazard, Meet Adverse
Selection. Retrieved from:
http://crookedtimber.org/2008/09/19/moral-hazard-meet-adverse-selection/
