I watched the interview of Bears Stearns CEO on TV . He had to appear because there were persistent rumours that the company had enormous subprime losses and was on the verge of some kind of catastrophe. He said the company was sound and had plenty of liquidity. 48 hours later, they had to be rescued by the Federal Reserve. The SEC has been monitoring this company for several weeks and issued statement a few days ago that the company has substantial liquidity to meet its needs. ....how did the company fail?
What brought Bears Stearns wasn't subprime losses, but clients who withdrew money thinking that there are bigger problems looming. There was panic and plenty of short selling that hammered it stock down by more than 50%. The CEO tried to explain that that the company wasn't insolvent and its fundamentals were still intact. ...but nobody wanted to listen. (the stock did recover after hours when the panic subsided).
This is a classic "run on the bank" - fear causes an otherwise sound business to collapse. The Fed is now put to the test. It has to calm the markets before panic start popping up everywhere and the problem becomes intractable. It has alot of work to do this weekend which appears to be pivotable to fix the Bears Stearn problem fast. This crisis will get worst or start improving next week when investors think the worse is over. Despite the rollercoaster ride, investors are not one bit braver now - they are as fearful as ever. Having been through the Asian crisis, sometimes all it takes is plenty of fear to bring an economy down.
The US$ is now S$1.37 and 99 Yen....traders appear to be "running on America". This resembles the Asian crisis. A debt problem transform into a currency problem which is then transform into panic. Bush also appeared yesterday to try to calm markets - he ended up giving reasons why he will veto a bunch of bills by Congress to try to solve the foreclosure mess because they were based on the wrong "principles" (or ideology?). He also said the US economy is resilient....I think it was resiliently piling up debt under his administration.
Bear Stearns' No. 1 foe: Fear itself
NEW YORK (Fortune) -- Bear Stearns isn't out of the woods yet.
The struggling brokerage firm spent Friday trying to assure fearful investors that it isn't on the brink of insolvency. CEO Alan Schwartz and finance chief Sam Molinaro used a midday conference call to emphasize that Bear Stearns' financial situation isn't as dire as rumors suggest. They said the firm sees Friday's 28-day financing agreement with JPMorgan Chase (JPM, Fortune 500) as buying time to "get more facts out into the marketplace."
But Wall Street wasn't buying it. Bear Stearns (BSC, Fortune 500) shares, after plummeting as much as 50% to an 11-year low on the announcement of the Fed-backed JPMorgan financing deal, held steady at much-reduced levels throughout Friday's conference call. The shares were down 38% at 1 p.m. EDT after the call wrapped up.
Schwartz and Molinaro insisted on Friday's call that there have been "no material changes" in Bear Stearns' financial strength in recent days, and that the firm expects its first-quarter results to be within the range of analysts' estimates when Bear Stearns posts its numbers Monday afternoon.
But Molinaro also admitted that Bear Stearns was in dire straits Thursday night, after some firms that trade with it - fearful about rumors of a liquidity squeeze at Bear Stearns - "no longer wanted to provide financing."
That comment shows that Bear Stearns is dealing with a classic run-on-the-bank. The firm's short-term creditors refused to lend the firm any more money via the extension of overnight loans, and simultaneously demanded repayment of outstanding debt. The one-two punch overwhelmed Bear's cash position, forcing it to seek help. Had the Fed not stepped in, it appears doubtful Bear could have operated today.
The stunning developments cut Bear Stearns' stock value as low as $26.85. The shares opened the week at $69.75 and traded as high as $159 last year.
With no counterparties willing to lend Bear short-term credit - the lifeblood of a securities firm - the firm's ability to function independently appears to be over. The firm hinted at the need to find a more lasting solution on the call when Schwartz said he viewed the JPMorgan financing as "a bridge to permanent strategic alternatives." Rumors have Bear Stearns talking with firms, including JPMorgan and China's Citic, which bought a big stake in the firm last year. But the stock market action Friday suggests few investors believe a deal is near.
In short, the Fed is allowing J.P. Morgan - a commercial bank - to act as a conduit for pumping cash into Bear Stearns. The bank is being permitted to give Bear Stearns collateral at the Fed's emergency-lending discount window to secure 28-day financing, which in turn is lent back to Bear Stearns in order to finance its business.
The Fed's role in the deal suggests federal officials fear a systemic collapse of the U.S. financial system were Bear Stearns to fail. The fear stems from Bear central role in a multitrillion-dollar web of interconnecting derivative contracts.
Rumors that Bear Stearns was on the verge of collapse started buzzing around Wall Street trading desks on Monday. Schwartz - who took over as CEO in early January from longtime chief Jimmy Cayne - appeared on CNBC Wednesday afternoon to reassure the markets that the firm was stable. Schwartz was right in one respect: The firm had about $17 billion in short-term capital available as of Nov. 30 and had a net cash position of $8.2 billion - more than it had previously.
Schwartz's problem was that none of Bear Stearns' counterparties cared about its ability to pay off debts in the long term. With the value of debt securities in a nosedive, lenders care only about recovering on the loans they have out now. And starting late last week, they began to call in those loans.
This played directly upon Bear's biggest weakness relative to many of its competitors: It is the smallest of the investment banks and doesn't have a consumer banking or retail investor business to draw upon. Almost daily, Bear Stearns has to renew a large percentage of its $102 billion worth of open repurchase agreements - or short term loans from Wall Street dealers - or make up the difference out of its cash position.
It's unclear what exactly started Bear Stearns' nightmare this week. Veteran repurchase agreement traders told Fortune.com that a major European bank last week refused to accept Bear Stearns as a counterparty to a large swap trade. By late Monday and early Tuesday, traders at hedge funds told Fortune that they were being charged a premium by the swaps desks at Deutsche Bank (DB), UBS (UBS) and Citigroup (C, Fortune 500) to execute trades with Bear Stearns as the counterparty or which involved its credit.
The bottom fell out on Thursday, Bear Stearns CFO Molinaro told investors. The demands for cash came from counterparties as well as hedge fund clients who wanted to close out their prime brokerage accounts. The market voted with its feet and wallets.
Bear Stearns' biggest challenge now is panicked investors, who see the firm's debt as extremely risky. The swaps market, for instance, was pricing Bear Stearns' five-year credit default swaps, which are contracts that function as insurance against the risk of default of the firm's debt, 730 on Thursday. This means that an investor who wants to insure against the default of Bear Stearns debt pays an annual premium of $730,000 per $10 million face value.
In contrast, at the height of another recent high-profile liquidity crisis, Countrywide Financial's (CFC, Fortune 500) credit-default swaps traded in the low 600s prior to its purchase by Bank of America (BAC, Fortune 500).
If the panic doesn't subside soon, Bear Stearns may the least of the Fed's problems.