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Bear Stearns - Could it have been foreseen?

Updated on April 8, 2008

Bear Stearns – Could It Be Foreseen?

Only a few days before the collapse, Bear Stearns employees were insisting that all was well, and that there was no liquidity crisis. Were they just trying to maintain outside confidence in the bank, and avoid a run on the assets, or did they really believe that there was no problem? What were the warning signs and was the structure basically unsound, and waiting for a problem to cause the collapse?

There is no doubt that investment banks, as with many other financial companies, rely on the confidence of those around them. If all debts were to be settled, there would be a marked shift in the way that society operated, and devastation in the markets while it sorted itself out. In that sense, we live in a world that is subject to catastrophic failure, and are very reliant on the structure to keep things running smoothly. So perhaps the question should be whether the Bear Stearns crash could be reasonably foreseen by a prudent person.

This situation is not without precedent. In June 1970, Penn Central, the largest railroad in the country and the sixth largest business, went bankrupt. This too was a matter of loss of confidence, with the lines of credit withdrawn, so that it was left owing over $200 million with no credit available. This created a general feeling of fear that other businesses would lose their credit lines, so the Federal Reserve stepped in and ordered its members to maintain liquidity in the markets. A consequence of this was the printing of money, and resultant roaring inflation.

There was a warning in the middle of last year, when Bear Stearns had two of its hedge funds crash as a result of the sub-prime crisis. Some investors were astute enough to ease their money away in the following months. Bob Sloan of S3 Partners, which advises on hedge funds, told his clients that there was a “30% to 35% chance” that Bear Stearns would collapse.

On the other hand, the CEO of JPMorgan, the bank that is involved in the bailout, said in a speech to Bear Stearns employees that “No one on Wall Street could have anticipated this.” Indeed, British billionaire Joseph Lewis was increasing his stake in Bear Stearns as recently as late last year, and now owns 8.4% of the stock with a very much reduced value.

One of the main points made about the collapse by some people is that it was becoming inevitable that something would have to give, and if not Bear Stearns it would have been some other company. The popularity of securitization, or the packaging up of mortgage loans so that they could be invested in and sold on as mere financial instruments, pays no heed to the fundamental basis of the debts. It’s been argued that such facilities have encouraged the housing bubble, by allowing much more investment in personal real estate. Borrowers who should never have qualified, or qualified for reduced amounts, have been able to obtain the money to chase up inflated prices on housing, a rudimentary example of supply and demand affecting prices.

As fraudulent buyers, with “liar loans” as the unconfirmed applications came to be known, and highly leveraged speculators took over the housing market and inflated prices, legitimate buyers were forced to respond, or be priced out of the market. Consequently, it was inevitable that a massive correction would be needed, and the market had to crash. Prices are in the process of becoming related to the real values, and those who had made money through encouraging reckless borrowing deserve to become bankrupt. The recklessness of the lending is confirmed by the dramatic increase in foreclosure filings. If the lending was affordable to the people taking it, then, regardless of the paper value of their property, they would still be able to make payments, and not lose their home. However, reduced starting interest rate mortgages, interest only mortgages, and other monetary vehicles have been invented in recent times to encourage over commitment by the consumer.

How would a reasonable person realize that Bear Stearns was the company that would be first to collapse? If there is an answer to that, it is bound partly in a conspiracy theory. Bear Stearns were the only investment bank that did not participate in a bailout in the last credit crunch of 1998, when Long-Term Capital Management were in trouble. Although they did not help with the costs, Bear Stearns benefited along with everyone else from the improved conditions in the marketplace. This latest event is considered to be payback, as the Federal Reserve could have acted earlier and prevented such a drastic outcome.

Given that such as enormous event was not even foreseen by billionaire Joseph Lewis, it shows that the individual investor is well advised to diversify; and the free trading course at will start you on the path to a better understanding and wiser choices.


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