Bear Stearns and the Seeds of its Demise

24 Pages Posted: 14 Jun 2009 Last revised: 10 Nov 2021

See all articles by Susan Chaplinsky

Susan Chaplinsky

University of Virginia - Darden School of Business

Abstract

This case is suitable for courses on corporate finance at the graduate or advanced undergraduate level that cover banking, financing, security design, capital structure, or capital markets. The case covers the events that led to the collapse of Bear Stearns's (Bear's) hedge funds in July 2007 and traces management's response to the situation through January 2008. These events include macroeconomic factors that fueled the housing boom, the growth of securitization, structured products, and credit default swaps, and the maturity mismatch of financial institutions' funding strategies. The case provides a rich setting for students to understand the increasingly interrelated nature of banking activities, which poses large systemic risk to the financial sector. Two key questions are posed: “What factors were responsible for the collapse of Bear's hedge funds?” and “Was the response by Bear's management adequate in light of the collapse and the credit problems that ensued?” John Corso is a hedge fund manager with large cash balances in a prime brokerage account at Bear. In January 2008, he receives a call from a senior Bear executive reassuring him that the firm is in good hands following a shakeup of top management. The previous summer, two Bear hedge funds collapsed as a result of their investments in collateralized debt obligations (CDOs) that were backed by subprime mortgages. As a longtime client of Bear, Corso must evaluate whether the steps taken by management have been sufficient to resolve its credit problems or whether now is the time to remove his funds from the firm.

Excerpt

UVA-F-1574

Rev. Jan. 8, 2019

Bear Stearns and the Seeds of Its Demise

“I just simply have not been able to come up with anything, even with the benefit of hindsight, that would have made a difference.”

—Alan D. Schwartz

John Corso hung up the phone on January 15, 2008. He had been talking with Michael Minikes, a senior executive at Bear Stearns (Bear). This was Minikes's second call in a matter of weeks. The first call had come in late December, shortly after Bear had disclosed a $ 1.9 billion write-off of bad loans. This time, Minikes had wanted to discuss Alan Schwartz's promotion to CEO following James E. “Jimmy” Cayne's resignation the previous week. Minikes reassured him that the firm was in good hands and was expecting better results this quarter. Corso understood the subtext of the call. During the past year, Bear had experienced a series of wounds—some self-inflicted and some not—and rumors persisted about the firm's ability to survive the current credit crisis because of its large exposure to mortgage-backed securities. Corso was the manager of an $ 800 million hedge fund that held its brokerage account at Bear. Though he himself had little exposure to the mortgage market, his long–short fund kept sizable cash balances at the firm. Corso had a long-standing relationship with Cayne and Bear going back many years. When certain regulatory issues had been raised about his fund in 2001, Bear had stood by him. Loyalty and admiration for Bear's grittiness had kept him a client so far. But with mounting pressures on the firm, Corso wondered if now might not be the time to move his business from Bear.

. . .

Keywords: investment banking, credit crisis, hedge funds, securitization, CDOs, liquidity

Suggested Citation

Chaplinsky, Susan J., Bear Stearns and the Seeds of its Demise. Darden Case No. UVA-F-1574, Available at SSRN: https://ssrn.com/abstract=1418914 or http://dx.doi.org/10.2139/ssrn.1418914

Susan J. Chaplinsky (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4810 (Phone)
434-243-7676 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/chaplinsky.htm

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