How Bear Stearns failed

What went wrong with Bear Stearns?
Why was Bear Stearns sold out just for $2 a share when just sometime back its share price was as high as $150 per share?

I’ll keep it short and simple. It was the subprime mortgage crisis that led to the fall of Bear Stearns.

Related: My view of Subprime Mortgage Crisis

How the 85 year bank Bear Stearns fell prey to subprime mortgage crisis? The real culprits are various investment banks – including Bear Stearns itself. These banks have to do business – with customers, high net worth individuals, with governments and with each other. They keep coming out with new and “innovative(?)” financial securities and instruments, which they trade with each other. In case of Subprime mortgage crisis, the same investment banks came out with a nice piece of mortgage backed financial securities.

What has happened is as follows: Subprime mortgages (basically loans to credit less individuals) were offered by the various real estate mortgage lenders (including different arms of big investment banks). Since they were offering loans, they required money to back them up. Hence these banks came out with “mortgage backed securities” and sold them to each other. These were the financial instruments, which had the guarantee of the real estate or houses that were sold through subprime mortgages.

However, when the subprime mortgage loan borrowers defaulted, these mortgage backed securities also went for a tailspin. The culprits were these investment banks who failed to realize the risks involved in these subprime mortgage backed securities and sold them aggressively. Bear Stearns is just one example of how one bank with 85 year old reputed history has fallen prey to market conditions.

Let’s also not forget what has happened with Northern Rock bank of UK.

Hopefully, this will be a new lesson to people who blindly keep on buying shares believing that banks are safe and have proper risk management systems.

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Northern Rock Bank Up for Sale: Bid deadline today 4th February

Northern Rock is a famous mortgage bank of UK. However, following the mortgage market meltdown in the past year, it is now to be sold out. It was one of the favourite banks of the UK citizens for taking easy mortgages or loans for buying properties like house, home, business, etc., but today it is up for sale.

Northern Rock landed itself into financial distress because of its incorrect business functions and models which had no room or preparations for what we know as the global credit crunch.

Unlike the other UK based banks, Northern Rock had devised the business model upon borrowing funds from the wholesale money markets to carry on or run its mortgage business, rather than the usual method of using the deposits of the savings account money which people leave to the banks in their savings account. Borrowing such money from wholesale money markets is not only costly, but also risky, as it does not have any backup for repaying the debt that the bank borrows.

Yet after the subprime mortgage crisis in the US which had the global effect, Northern Rock suddenly found it could not secure the cheap funds it needed, as credit was either unavailable or was found to be more expensive.

As the first emergency loan from the Bank of England was announced, thousands of Northern Rock savers rushed to withdraw their funds, before the government's pledge to guarantee all savings. This caused mayhem in the banks money, as saving bank account holder had withdrawn their money and bank was left ailing with less cash, despite the help or emergency aid from the Bank of England.

Now, the FSA or the Financial Services Authority (like that of RBI in India and Fed in USA), is being criticized for not keeping a close eye on the way the bank was functioning. As per the news, Northern Rock's senior managers were most at fault, it also blames that the FSA was guilty of a "systematic failure of duty" in not preventing the bank's "reckless" business plan.

It’s up for sale now. Sir Richard of Virgin Atlantic has already confirmed that Virgin aims to meet the deadline, and is said to be the frontrunner. Along with him, 2 more bidders are expected to be interested in the buying the bank. Under the sale to a private buyer, the government intends to turn the £25bn of Bank of England loans - essentially taxpayers' money - into bonds, which will then be sold to investors. It is not yet known when the government will announce which bid for Northern Rock has been successful.

People who believe that banks which are in the business money savings and money lending or are aggressive in the real estate loan markets, should think again. We have already seen the fate of Global Trust Bank. Recent news was about the losses reported by French bank Societe Generale or SocGen, saying that one of its traders did a scam. All those are affected are the shareholders of the bank.

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