It's been awhile since I've heard anything about the Bear Stearns collapse. Nobody seems to care anymore. A year ago, most investors would have scoffed at the possibility of its collapse. They would have assumed that the fallout from the failure of a large financial firm might as well mark the end of the world. Alas, it happened. Bear Stearns fell. Yet the market hasn't crashed, hedge funds haven't fallen into an abyss, and, thank heavens, the sun still rises over Wall Street.
Good thing, too. Because a Bear Stearns-style implosion might easily happen again.
Get ready
According to a survey from Greenwich Associates, nearly 60% of 146 institutional investors polled expect another major financial firm to collapse in the next six months, and another 15% think it'll happen within the next year.
Now, it'd be easy to brush off that statistic if institutional investors were merely annoyances in the finance world. In other words, that kind of pessimism wouldn't be a big deal if it didn't have an effect on the future of the financial firms they're worried about.
But it does.
When neighbors attack
Sure, Bear Stearns probably dug its own grave with a collection of collateralized debt obligations and credit default swaps that nobody, even it, could decipher. But what cast the final blow back in March was a swift exodus among counterparties -- other banks and institutional investors. In other words, there was a run on the bank that squeezed the life out of Bear's cash supply before it could do anything about it.
Consequently, some of the same investors who are overwhelmingly predicting another collapse are the same ones who can actually cause another collapse. That's a lethal combination, especially when the same investors can make a quick buck doing so.
And, oh, how they can make a quick buck. Bloomberg recently reported at least one investor purchased a block of put options just days before Bear failed -- a purchase so large and so incredibly bearish (pun intended) that some observers think the buyer may have purposely tried to drive Bear into an all-out collapse. In the end, whoever made the freakishly pessimistic bet reaped a profit of more than a quarter-billion dollars.
Now there's another variable in the equation: Some of the same investors who predict another collapse and have the power to cause another collapse have an opportunity to make a fortune off another collapse. We'll leave calculating the odds up to the statisticians, but that trifecta of factors doesn't bode well for those predicting that the worst is behind us.
Great -- so who's next?
Trying to measure pessimism in advance is a tricky business. One thing investors learned from Bear Stearns is that as soon as someone sounds the alarm, there's no time to escape. Bear went from allegedly well capitalized to virtually well nationalized in a matter of hours. One thing we can look at, however, is the extent to which short-sellers have ganged up on investment banks. Here are some short-selling numbers on some of the largest banks:
|
Company
|
One-Year Decline
|
Short Interest*
|
Percentage of Float Sold Short
|
CAPS Rating (Out of 5)
|
|
Goldman Sachs (NYSE: GS )
|
(7.3%)
|
15.05 million
|
3.90%
|
***
|
|
Merrill Lynch (NYSE: MER )
|
(66.4%)
|
63.02 million
|
6.40%
|
*
|
|
Lehman Brothers (NYSE: LEH )
|
(72.5%)
|
85.32 million
|
12.70%
|
*
|
|
Morgan Stanley (NYSE: MS )
|
(29.2%)
|
47.13 million
|
4.30%
|
**
|
|
UBS (NYSE: UBS )
|
(63.1%)
|
15.88 million
|
<1%
|
*
|
|
JPMorgan Chase (NYSE: JPM )
|
(14.3%)
|
56.71 million
|
1.70%
|
**
|
|
Piper Jaffray (NYSE: PJC )
|
(31.5%)
|
3.02 million
|
16.80%
|
*
|
*As of 7/10/08. Source: Yahoo! Finance.
Lehman Brothers and Piper Jaffray appear to be destined for doom, judging by short-sellers' actions. Of course, this is nothing new: For months, Lehman has been on the receiving end of short-selling attacks, some of which were fueled by unsubstantiated buzz. There's no telling how far investors will go when there's so much money to be made exaggerating a company's troubles.
Maybe the worst is behind us. I hope it is. One thing is for sure, though: Until the deluge of rumors and pessimism begins to wane, it's nearly impossible to determine the future of investment banks. Sure, all of this hoopla will work its way out in the long run, but remember what John Maynard Keynes taught us: In the long run, we're all dead.
For more on the Bear Stearns collapse, financial panics, and short-seller attacks, check out:
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