Thursday, March 19, 2009

Bear's House of Cards

There’s a new book about the collapse of Bear Stearns. It’s House of Cards: A Tale of Hubris and Wretched Excess on Wall Street by William D. Cohan, and it is getting good reviews. The New York Times calls it “...high drama that is gripping...”

The story may not seem so relevant or interesting today. After all, Bear’s demise was a year ago; Lehman’s was only last September. Bear’s vital organs were saved by transplant into the body of J.P. Morgan; Lehman was allowed to expire in the emergency room.

But we think the book will answer questions about Bear that are as urgent and compelling today as they were when the company failed. What brought the Bear down? Was it just arrogance, or did negligence, ignorance, or bad luck play a role? Was it ruthless attacks by short sellers or mainly extreme market conditions?

Mistakes in Liquidity Management
Whatever else contributed, mistakes in liquidity management were important in the company’s downfall. Thanks to the failure of two of its own hedge funds, Bear was painfully aware of problems in the financial markets. It took steps to improve liquidity, increasing cash and unpledged securities from $27.7 billion in November 2007 to $35.2 billion in February 2008.

It was too little, too late. By Bear’s own reckoning, those sources of liquidity in February had to cover at least $21.7 billion in potential uses, including maturing unsecured debt, funding commitments, and standby letters of credit. That left only $13.5 billion to cover client withdrawals and secured funding shortfalls.

At the time, Bear owed $91.6 billion to clients and had secured short-term debt of $98.3 billion. It would take only a small percentage decline in either of those amounts to exhaust the company’s liquidity reserves, and it did. In the three days starting March 10, Bear went through $12.1 billion in cash alone and was forced to turn to J.P. Morgan and the Federal Reserve for a rescue.

Bear failed to anticipate its liquidity needs. We’ll have to read Mr. Cohan's book to learn if it was through bad management, because of unprecedented illiquidity in the financial markets, or on account of those nasty short sellers. We can’t wait to find out.


Jessica said...

great blog in general but would love more bits of corporate credit analysis. ANybody know of any other useful blogs or wesbites?

Tim Delaney said...

Take a look at the links on the bottom right of Comments on Credit. And let us know if you come across other sites you think we should list there. What aspects of credit analysis would you like to see more of in this blog?

Jessica said...

Thanks for your reply. I work in a commercial bank doing corporate credit analysis of SMEs and really appreciate some of the more applicable pieces that you've included such as analysing working capital, structures, etc. I've looked at the blogs you list but these seem to be taking a higer level view of credit rather than offering the practical ideas that I can incorporate into my work. Do you have any recommendations of good books to read?