A two-dollar bill taped over Bear Stearns’ logo at its Madison Avenue headquarters just about said it all. On March 16, 2008, after a profound loss of confidence by Bear Stearns’ lenders, circumstances — and the federal government — pushed the venerable investment bank into the arms of JPMorgan Chase & Co. (NYSE:JPM) for a mere $2 per share.
Though the deal was later recut to $10 per share, it was cold comfort to employees and major Bear investors. The week prior, shares changed hands at $70. In January 2007, the stock had fetched more than $170.
Ask why Bear fell, and perhaps the best answer is the easiest: leverage. At the end of the last quarter before its fire-sale, the bank was levered at nearly 34-to-1. At that nosebleed level, a mere 3% drop in the value of its assets was all it would take to wipe out its entire equity base.
In essence, Bear was betting the house on its traders, bankers, and managers being right… all the time… or else.
But while some versions of the pre-crisis Wall Street narrative suggest that banks — and investment banks in particular — got risky in the period just preceding the crisis, this penchant for balance-sheet risk-taking wasn’t new at Bear. Look back over the decade preceding its collapse: Bear almost continually kept an end-of-year leverage ratio approaching, or above, 30. And at many Wall Street firms, the end-of-period leverage ratio is considerably lower than what they’re running around with mid-quarter.
It’d also be a mistake to say this was an infection of the late 1990s and early 2000s. Though many — including past Bear leadership — point fingers at former CEO Jimmy Cayne, Bear was a swashbuckling outfit. The bank was full of high-octane financiers making a name for Bear by taking on trades and business lines that competitors often wouldn’t. They were voracious card players. They were gamblers.
Bear Stearns had a long and successful history. But in many ways, it was a powder keg of risk, just waiting for the right crisis to blow the entire edifice to bits.
The leverage ratio, of course, no more tells the whole story of Bear’s collapse than the Battle of Yorktown tells the whole story of the Revolutionary War. The nature of Bear’s financing — and that of its competitors — played a significant role. With roughly a quarter to a third of its liabilities coming from short-term repurchase agreements, there was little guaranteed stability in the ground on which the firm stood.