Sunday, March 16, 2008

Why Bear Stearns is collapsing UPDATED

UPDATE: JP Morgan is going to buy Bear Stearns...for ONE FIFTEENTH the price that it was at close of market on Friday:
The deal calls for J.P. Morgan to pay $2 a share in a stock-swap transaction, with J.P. Morgan Chase exchanging 0.05473 share of its common stock for each Bear Stearns share. Both companies' boards have approved the transaction, which values Bear Stearns at just $236 million based on the number of shares outstanding as of Feb. 16. At Friday's close, Bear Stearns's stock-market value was about $3.54 billion. It finished at $30 a share in 4 p.m. New York Stock Exchange composite trading Friday.
Emphasis added. What happened between Friday afternoon and now that would cause Bear Stearns to lose 93% of its value? Or what did the boards of those companies (who approved the deal) know that the investors on Wall Street didn't? Some one clue me in, please.

DailyKos's pontificator is equally flabbergasted:
That is ridiculous. The Wall Street Journal was reporting a sale for $2.1 billion just hours ago. $250 million is less than one quarter of the value of Bear Stearns' freaking office building. They should have just sold it for $1 and gotten it over with. In Wall Street terms, selling an entire financial services firm like Bear Stearns for $250 million is not much different than selling it for $1.

[original post]

I think we have the answer right here, buried at the end of this this NYT article:
The demise of the hedge funds began a slow but persistent loss of market confidence in the bank. Such an erosion can be devastating for any investment bank, especially one like Bear Stearns, which has a leverage ratio of over 30 to 1, meaning it borrows more than 30 times the value of its $11 billion equity base.
(via Marginal Revolution) Holy fucking shit. I did not know this. Any institution that borrows over 30 times its equity base deserves to go under. And the financial sector deserves a good slap upside the head for letting this happen. What sort of idiot lends money to someone who has already borrowed 30 times its value? Is there something I'm missing here?

P.S.: Here's a good article on the risky schemes some hedge funds might be using to make great returns (at the risk of utter collapse if the bets go wrong).


Anonymous bill in minneapolis said...

Regular banks are regulated by the Federal Reserve and must have reserves of 5-10% of their outstanding loans - so they can be leveraged between 10 to 20 times their equity.

Non-regulated financial institutions like Bear Sterns have used the worldwide excess in saving (non- U.S.), to super leverage themselves (30 times).
You can get a 30% return on your equity this way plus lots of fees, but it exposes you to risk.

Greedy, greedy, greedy.

7:19 PM, March 16, 2008  

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