Bear Stearns: 1 Year Later

Can you believe it? One year ago today, markets learned that Bear Stearns had gone kaboom, agreeing to be sold to JPMorgan Chase (NYSE:JPM) under an initial $2-per-share deal backstopped by the Federal Reserve.

And, man, we thought it was bad at the time. It was, of course, but so many important players didn't realize Bear's collapse was just the opening act of the market's unraveling. "I think the credit panic ended with the collapse of Bear Stearns," then-legendary money manager Bill Miller said last April. His faith kept him heavily invested in financial stocks, which led to the end of his reign as money-manager extraordinaire.  

He wasn't alone. The notion that the worst was behind us was strengthened by a sense that Uncle Sam could, and would, save those who failed. Disaster had been averted. The worst was over. Carry on. Nothing to see here.

Yeah, about that
But let's say Bear Stearns had been allowed to go bankrupt. How would the events of last fall have been different? Bear was smaller than Lehman Brothers in terms of total assets, but quite a bit more intertwined in the toxic credit default swap (CDS) market. If Lehman's failure is any indication, it's pretty apparent that a bankrupt Bear would have been a disastrously violent Bear as well.

But let's say it did go bankrupt, and somehow the sun still rose the next day. How would the world have changed? Surviving banks would have likely gone into fortification mode, shedding assets and raising capital as fast as humanly possible, seeing clear as day how dangerous this game was.

And they could have made some serious progress. Foreign investors still had an appetite for bank assets. Credit markets were flowing relatively well. By share price alone, banks were in a much better position to raise capital a year ago then they are today:

But most didn't. The worst dillydallied around with "planned assets sales" (that never happened), planned capital-raising (that never took place), and a steady insistence that everything would be fine. After Bear's rescue, the fear of failure was artificially buried.

In fact, after Lehman collapsed in September, former CEO Dick Fuld was asked by Congress why he thought AIG (NYSE:AIG) was bailed out while Lehman was left to die. "I would have loved to be part of the group that got ..." he said, stopping himself before saying something stupid. He continued, "Until the day they put me in the ground, I will wonder."

If you want to see a clear picture of what moral hazard looks like, there it is. Even the most ego-driven, head-stuffed-with-entitlement CEO's biggest question wouldn't have been "Why didn't you bail me out" without an existing conception that that was how failure was handled.  

So, why Bear?
Which makes you wonder: Why did Bear Stearns get into such a pickle? How did it ever think it'd make it out alive without knowing that life jackets would be thrown at it the day things went sour?

One possible explanation is to go back 10 years, to the 1998 Long-Term Capital Management meltdown. (Click here for the full story).

As the Nobel Laureate-laden hedge fund which used 100-to-1 leverage to trade derivatives worth $1.25 trillion teetered on collapse, 14 Wall Street banks held hands and bailed it out. Banks didn't do this just to save their own butts on money they lent the hedge fund, but to save the entire financial system as well.

The lone dissenter that refused to help? Bear Stearns.

Bear was able to leave the burden of the financial system's problems on other banks without any serious ramifications. It enjoyed the benefits of a market that still worked the next day without having to lift a finger itself. That almost certainly left it with a feeling of "Someone else will always have your back. Take risks. Have fun. Leverage up. Ignore danger. Everything will be OK. It always has been. We're freakin' immortal."

Bottom line
So here we are, one year, a few trillion dollars, and several failed banks later. We've belabored whether saving the financial system from systemic collapse has been beneficial, but one thing is irrefutably clear: Protecting the financial system without allowing a company to feel the full wrath of its mistakes doesn't solve a problem. But we still do it. We've pumped hundreds of billions of dollars into Citigroup, Bank of America, and AIG, but allow them to keep operating with the hope that they'll get it right the next time.

How long can that last? Who knows? Let's see where we end up a year from today.

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