Bear Stearns' Flesh Wound

Reading the comments of Bear Stearns (NYSE: BSC  ) CEO James Cayne in the firm's latest press release, I couldn't help thinking of the words of the Black Knight in Monty Python and the Holy Grail. Dancing around with no arms, the Black Knight cries that his injuries are "just a flesh wound." The Friday press release was a response to the change in S&P's rating outlook for the firm from "stable" to "negative."

Now to be fair, Bear has hardly had its arms cut off. But at this point, it's a bit hard to believe Cayne's suggestion that the industry themes that S&P cited won't have a disproportionate effect on Bear versus other investment banks like JPMorgan Chase  (NYSE: JPM  ) , Goldman Sachs (NYSE: GS  ) , and Lehman Brothers (NYSE: LEH  ) .

So far, Bear's problems have come from its hedge funds. The problems could be compared to a nasty rash -- sure, it's been uncomfortable and it's had the effect of keeping people at a distance from the company. The million-dollar question, though, is whether this rash is just a rash, or whether it's an outward symptom of a larger, looming, systemic problem.

Even in the best-case scenario -- where it really is just the hedge funds with heavy losses -- the ramifications will still likely be painful. To do what they do best, investment banks rely on the ability to draw on borrowed capital. As might be expected, events such as hedge funds heading into bankruptcy or an outlook change from S&P tend to make it incrementally harder (or just more expensive) to find capital to borrow.

As often happens when a company has a very public fall from grace, heads are rolling. On Sunday, the firm announced that co-president and co-COO Warren Spector had "resigned." Spector is a former mortgage-securities trader who had risen up through the ranks during his 20 years with Bear.

The intended effect of such a drastic move is to try to restore confidence and show investors and lenders that Bear means business about controlling the situation. At this point, though, the burden is on Bear to prove that the disciplined risk management that it has been known for will prevail over mortgage market hubris.

More financial Foolishness:

JPMorgan Chase is an Income Investor pick.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants ...


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