Bear Stearns' Management's Naivete

Earlier this week, I read the second part of the Wall Street Journal's retrospective series concerning the demise of Bear Stearns. The piece ended with the following passage,

"At about 6:45 a.m., Bear Stearns officials received an email from Stephen Cutler, J.P. Morgan's general counsel. It was the draft of a news release announcing that the bank had agreed to provide Bear Stearns with financing "as necessary" for up to 28 days.

The money underwriting the rescue was coming from the Fed, which was also bearing the risk of the loan. It was the first time since the Great Depression that the Fed had made a loan like this to an entity other than a bank. It would provide the bailout through J.P. Morgan, because as a commercial bank the firm already had access to the Fed's discount window and was under the central bank's supervision.

Inside the sixth-floor conference room where Messrs. Molinaro, Upton and others had huddled, executives cheered and exchanged high-fives. They thought they had four weeks to sort out their problems."

When I read that last paragraph, I just shook my head. Those guys must be idiots.

The bulk of the article described the steady drain of customer assets and counterparty business fleeing Bear Stearns that week. Anyone with as much experience in financial services as Cayne and Schwartz should have remembered how quickly Continental Illinois Bank went from healthy to shuttered.

Once customers and counterparties smell weakness in a leveraged financial institution, it's over. Nobody will risk their cash with a counterparty or custodian who might, on any day, suddenly become insolvent. It's more than just 'staying away until the dust settles,' as one institutional customer told their Bear contact.

With sufficient numbers of other trading houses in the sector, who needs to do business with a cripple what might collapse in the next day's market decline?

What were those guys thinking? Did they really believe that the 11th-hour loan, brokered by the Fed and run through Chase, would actually save them? They didn't have a month to 'sort out their problems.'

They never had more than that weekend, because as soon as Monday morning's market open, every remaining customer would flee the obviously-weakened firm, and counterparties would step back, too.

You don't have to be a rocket scientist to understand that the Thursday night loan simply got Bear through one last day before a weekend deal to arrange the transfer of positions to whomever became the new owner of what remained of Bear Stearns.

I haven't read part three of the series yet, but the end of part two just left me incredulous that the guys at the top of Bear Stearns could have been so naive and clueless. Truly, they did not deserve to continue their corporate existence.