The Tip of the Iceberg: JP Morgan Chase and Bear Stearns – Research Paper Example
College: Bear Stearns The company was founded in the in 1923 as an investment bank. In the early 2008, it was considered the largest bank in the United States. The company had been taking big risks in pursuit of big profits. The Bear operating environment included capital market, global clearing services as well wealth management. Mortgage related securities formed the largest part bear’s balance sheet. Bear was also one of the lending underwriters of US mortgage backed securities during the period of 2004-2007 (Mody 100)
As an investment bank, Bear did not direct access to Federal Reserve discount window unlike commercial banks thereby forcing the bank to depend solely on the market for its liquidity and funding. The activities were financed with long term debt, equity and financing collateralized with securities from bear’s inventory (Mody 150). This forced the firm to constantly hold an inventory of securities that were collateral for short term borrowing agreements know as repurchase agreement (repos). The repos lenders were mainly institutions with excess cash seeking to earn high return on their excess liquid overnight. The repos lender enjoyed protection based on credit worthiness of borrower and the quality of their underlying asset that secured the loan. These assets included high quality assets such as mortgage back securities and US treasury securities. The bear had large liability in its balance sheet as repos borrowing and long term debt (Davidoff 120)
The US financial market problems started in the year 2007 then reached unprecedented level in 2008 mainly in the US housing market. This was because mortgages and home equity loans were packed and sold in securities that were to be sold as invests. The downward pressure of housing prices had a catastrophic effect and caused a lot of panic in US financial market. The subprime crisis began when the two Bears hedge funds collapsed. Prime brokerage was also a factor as Bears and other banks provided financing to hedge fund and held these funds as securities for safe keeping even though the securities were property of hedge funds and not prime brokerage (Greenberg & Singer 38). Bear Stearns Asset Management high grade structured credit strategies fund and High Grade structured Credit Strategies Enhanced Leverage fund had invested heavily in illiquid CDS tied to backed securities. Bears decided to off load the troubled mortgage securities using a new company called Everquest Financial even though the project was unsuccessful as many investor were unwilling to trade in the IPO therefor the initiative was cancelled. To that effect the investor started asking their money back especially after concerned were raised about Bear’s Fund performance Report. The funds decided to sell their asset so as to meet the financial obligation of the investor. This causes a downward pressure on value of their holdings (Ferrell, Fraedrich & Ferrell 78).
In the housing market the prices of houses started to depreciate as many house owner decide to foreclosure the house and look for alternatives. Raising default rate reduced the value of mortgage backed securities as results many institutional investors were unwilling to hold securities with an evident risk of being unsafe (Grant 90). The absence of liquid trading market for these securities forced the investors to seek bid for their securities from commercial bank and investment bank that created and sold to them. This forced the banks to mark the price down at which they will buy them at given price. The marking down of the price resulted in a vicious circle. This culminated to downward prices of the bonds in return causing the investor in a hurry of selling them at even more downward prices. This forced the Bear Bank to accumulate large amount of inventories of these securities which were valued at a lower price as result of economic pressure and pressure from investor to exit their position (Davidoff 120).
To serve the US financial market from free fall the Federal Reserve decided to use JP Morgan to acquire Bears Investment Bank within 24 hours with $2 per share but later adjusted it to $10 per share after complains from employee. The Federal Reserve provided JP Morgan with $30billion to backstop any loss JP Morgan Chase bank may incur on Bear’s liquid assets (Greenberg & Singer 45).
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