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Our next case study in the investment bank of Bear Stearns.

We've already talked about Bear Stearns in a previous module where we discussed

the Bear Stearns funds that they had that were investing that were not funds that

themselves their own assets, but

rather funds that they managed that had invested in subprime securities.

Which in June of 2007, they suspended redemptions and

then in July of 2007, brought back onto their balance sheet.

That's just one small part of a very large investment bank that

by mid-2007 had assets of about $400 billion.

They were significant players in all parts of the subprime space.

They were in loan origination, so they actually owned firms that went out and

made the sales and then they would take the mortgages and

warehouse them before they actually sent them out in securitizations.

They traded all kinds of subprime securities and

they were in the asset management business where they had funds that specialized in

buying those securities in the open market, often on a leverage basis.

As discussed, their first problems happened in the middle of 2007,

they suspended redemptions in two of their funds.

They took those funds back on their balance sheet,

effectively bailing them out.

Once again, for reputational reasons, paying off the lenders of those funds, and

taking all of the collateral,

everything that the funds had, onto its own balance sheet.

So you think about what that means for a moment.

I'm a large institution, I have a business that

manages money for other people, so it's not actually Bear Stearns' money.

That business gets into trouble and Bear Stearns says, we want future customers

of Bear Stearns to understand that we will stand behind our products, if we have to.

So they effectively just buy the fund.

Its a bail out of a private company for some of their products.

They take over the fund, they pay off the lenders and

they say we will take all the assets of those funds back on our balance sheet.

Now that's gonna be a hit to Bear Stearns, and it was a hit.

But that, plus other hits that they had to things on their balance sheet

are not nearly enough to drive them into insolvency.

It's not the case that the funds, while we are talking billions of dollars,

is not nearly enough to wipe out Bear Stearns' equity level.

Here's what happened in the last week, or in the weeks leading up to and

then the last week, of Bear Stearns' existence as an independent company.

That makes us think, what happened?

This is their liquidity, so

the amount, think of it just as their cash that they could access on any given day.

That number hovers between $15 and

$20 billion per day in February of 2008, leading into March of 2008.

We then see, starting on March 9th, a liquidity level of nearly $20

billion collapsed to zero over that week, $20 billion down to zero.

This is an investment bank that has no retail deposits.

There is nothing obvious here to run.

Yet, it goes from really being a very substantial organization

to being gone over the course of a week.

This had a very profound effect on me, personally,

at the time, just intellectually.

My father worked at Bear Stearns, he was there at the time, and

I talked to him throughout this week.

At the beginning of the week, he was of the view that they had

an enormous amount of liquidity, and so there were rumors in the marketplace but

there was an enormous amount of liquidity and they should be fine.

But he understood by the middle of the week that that was not true anymore and

by the end of the week, that they wouldn't have a business anymore

unless they managed to find somebody with more liquidity,

in this case JP Morgan to take it over.

This was very surprising to me because I really understood how this could happen to

a traditional bank but it was not obvious how you could get a run on a investment

bank, or on some firm that was in the wholesale finance system.

Again, that's really quite the puzzle of the global financial crisis.

In the next lesson, what we will do is talk about what were the things that made

this liquidity go from 20 billion to zero.

What are the pieces that are akin to a run on the bank?

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Lecture: Bear Stearns, Part I

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