Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

JPMorgan Chase & Co. (JPM), Goldman Sachs Group, Inc. (GS): 5-Year Anniversary: The Epic Collapse of Bear Stearns

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.

PMorgan Chase & Co. (NYSE:JPM)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.

A Dangerous Addiction to Leverage | Create infographics.

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.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.