On January 18th, 2007, Bear Stearns stock reached an all-time high, valuing it at over $20 billion. Just 14 months later, the company was gone. How it happened is the story of the fascinating book Street Fighters.
Cracks in the Facade
Bear lacked the polish of a firm like Goldman. But its traders had come to dominate the massive market for mortgage-backed securities.
As house prices soared in the 2000’s, Bear made huge profits.
But once prices began to falter, Bear’s mortgage securities started losing money. Soon, the word spread that Bear was taking big losses.
Counterparties began to pull huge sums from Bear, draining the company of cash. The many hedge funds that relied on Bear as a prime broker didn’t want their money stuck on a sinking ship.
Bear was losing money fast, sometimes billions in a day. Meanwhile, it struggled to get new loans to make up for the losses.
A Financial House of Cards
To me as a tech guy, the way Bear ran its finances seems insane.
It leveraged itself 30:1. A 3% loss would take down the company.
Surely you’re going to take a 3% loss eventually, right?
Worse yet, much of Bear’s borrowing was via overnight repo loans. They easily rolled those loans over every day, until one day they couldn’t.
Imagine financing your business that way — 30:1 leverage, and not knowing from day to day whether you’re still alive.
It’s deranged. But on Wall Street at the time, it was common practice.
Compare that to how the best businesses in tech finance themselves.
Rahul at Superhuman keeps a minimum of 4 years runway in the bank at all times. Big public tech companies keep even more cash — Apple is sitting on $62 billion.
Apple is still here. Bear is not.
No wonder technology companies are taking over the world.
Asleep at the Wheel
Dictatorial, lazy managers let Bear fall apart.
CEO Jimmy Cayne barely worked despite collecting an eight figure salary. He left on Thursday afternoons to play golf at his New Jersey beach house. He spent another couple of months per year playing in bridge tournaments and lounging in Florida.
Other executives followed his lead. Soon, several were leaving early each week to go to their vacation houses.
When Cayne was present, he brooked no dissent.
Board minutes were written up before the meeting even happened. Members were often told to read from prepared statements.
This guy is one of the worst managers I’ve ever seen. The average Joe off the street could’ve done better.
The End of the Line
By March of 2008, Bear was nearing the end. Between counterparties pulling their accounts or demanding more collateral, the firm was running out of money.
New CEO Alan Schwartz and his team tried to find funding wherever they could: Japanese banks, the Germans, even private equity investor J.C. Flowers. Flowers tried to bring in Warren Buffett, but Buffett declined, citing his bad experience investing in Salomon Brothers.
That left one viable suitor: J.P. Morgan.
Jamie Dimon Saves the Day
JPM had the cash and the clout to get a deal done fast. The JPM and Bear teams spent a sleepless weekend at Bear Stearns headquarters at Madison and 46th Street. (I’ve been past it — it’s quite a nice building.)
On March 16th, JPM agreed to acquire Bear for $2 a share (later revised up to $10). The stock had been worth $170 just a year earlier.
The deal would’ve never happened if the Fed hadn’t agreed to backstop up to $30 billion in losses on the Bear portfolio.
The Fed and Treasury never seemed to seriously consider letting Bear go bankrupt. Why they so readily put government money on the line is unclear.
Why can’t these banks go bankrupt like anyone else?
Wrap-Up
I found the story of Bear’s last days fascinating.
This is what happens when you take ridiculous risks. You make big money for a while, and then you get kicked in the face.
When you look at the most successful companies of today, like Apple, they look nothing like Bear. They provide value to customers and run their finances conservatively.
Slow and steady wins the race.
What do you think of Bear Stearns’ demise?
Have a great weekend everybody!
More on markets:
From $50 Million to $50 Billion: Thomas Laffont at the All-In Summit
My Next Move in this Turbulent Market
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