Economic Crises Case Study

2008 Bear Stearns Collapse: Lessons from the Sub-Prime Crisis

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Abstract:
The near collapse and bail out of Bear Stearns, one of the popular icons of the investment banking sector in the US, took the financial community by surprise and left a trail of mistrust in investors, which eventually dried up the liquidity and magnified the impact of the sub-prime crisis. Overexposure of Bear's hedge funds to sub-prime mortgage lending, and over dependence on short-term money markets for its excessive borrowings were the main reasons for Bear's fall. The Federal Reserve Bank's initiatives of rescuing Bear met with both praise and criticism from various quarters. The case focuses on the expansion of sub-prime lending on the back of the housing bubble, key lapses which triggered the crisis, and the lessons which can be learnt from the sub-prime episode.

Pedagogical Objectives:

• To the difference between traditional and sub-prime mortgage finance, and the securitisation process of mortgage securities.
• To Bear Stearns' excessive exposure to mortgage finance, and the failure at management level to assess the consequences.
• To the mismanagement of risk by assigning inflated ratings to garner more market share.
• To the fallout of the crisis and the eventual bail out of Bear Stearns to avoid financial implications.

Keywords : The housing bubble, Interest rates, Securitisation, Mortgage lending market, Short-term money market, Optional ARM's (adjustable rate mortgages), Derivatives, Foreclosures, Exotic securities,Hedge funds, Speculation, Jimmy Cayne, Rating agencies, Discount window loan, The Federal Reserve Bank