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Home > Cases > Bear Stearns Hedge Funds > The Downfall of Bear Stearns: What It Means

The Downfall of Bear Stearns: What It Means

The sudden downfall of the mighty Bear Stearns adds more fuel to an already flaming fire that America's financial system might be headed for big trouble. Or, at the very least, it's experiencing an unprecedented crisis in confidence.

Once the country's fifth-largest investment bank and the darling of Wall Street, Bear Stearns Cos. has become part of a long list of victims taken down from the fallout of the subprime securities crisis and the ensuing credit crunch.

Rumors of the company's demise started circulating in early March, and were made official on March 14, 2008, with the announcement of a takeover bid by J.P. Morgan Chase and a bail-out plan engineered by the Federal Reserve.

Pushed to the brink, Bear Stearns agreed to be sold to J.P. Morgan Chase & Co. for a fire-sale price of $2 a share in stock. About a week later, following pressure from disgruntled Bear Stearns shareholders, JP Morgan sweetened its offer from $2 per share to $10.

The sale of Bear Stearns—and the Federal Reserve's unique involvement—underscores what's been in the news for months: The country might be headed down the path to one of the most pervasive financial predicaments in decades. A March 24 editorial in the Wall Street Journal offered a fitting description on the possible financial meltdown facing the nation: “In the credit market panic that began in August, we have now reached the point of maximum danger: A global run on the dollar that could become a rout.”

From Wall Street to Main Street
Prior to the collapse of the housing market, Wall Street was more than eager to buy subprime loans, mix them with other types of debt and repackage them into complex securities that were sold to investors. That was all well and good—for awhile.

Then the housing market began its historic decline, and borrowers defaulted in record numbers on their mortgages. One crisis led to another and the domino effect took hold: Outstanding subprime mortgage defaults caused the complex securities that Wall Street had created from those mortgages to crumble. Among the biggest underwriters of the complex investments linked to those mortgages? Bear Stearns.

More than Wall Street's failure, however, Bear's demise reveals much deeper problems for the nation and its citizens. Consider the following:

  • If investment banks are unable to function properly, the financial system could come to a standstill. Municipalities that rely on the public sale of their stock would be hard-pressed to raise money to fund infrastructure projects such as roads, bridges and airports. Businesses would be unable to expand or create jobs. Massive layoffs might ensue.
  • It wasn't so much that the Federal Reserve, in all its wisdom, was concerned with Bear Stearns going bankrupt as it was with the possible “ripple effect” that might follow with other banks in similar situations.
  • The collapse of a flagship financial institution like Bear Stearns creates widespread uncertainty which, in turn, thoroughly rattles Wall Street. If lenders think there is a chance that borrowers will default, they won't make loans. In the U.S. economy, credit is its bread and butter—if no loans are made, the economy could, for all practical purposes, shut down.
  • When the Federal Reserve cuts interest rates, yields on money-market mutual funds and bank deposits fall, and stock prices continue to be extremely volatile.
  • Lower interest rates reduce the value of the U.S. dollar. As interest rates fall in the United States, global investors sell their dollar holdings to fund investments with higher returns.
  • The United States relies on foreign cash to finance massive trade deficits. When private investors vanish, the government is more dependent on foreign central banks—banks that have become increasingly selective about which U.S. assets they will buy. The shift into super safe U.S. Treasuries from other types of investments further escalates a credit crunch that has already gone from bad to worse.

The bottom line: If we think the collapse of Bear Stearns has no meaning in our life, think again. And while panic may be too strong of a word, it is without a doubt a time for concern. If a behemoth like Bear Stearns can be toppled, what does it say for the rest of us?

In the summer of 2007, our group, who individually and collectively have extensive experience in representing investors against Wall Street, formed an affiliation. Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage related investment losses.n confronted with subprime and other mortgage-related investment losses.


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