Professors Plan Bear Stearns Case Study

Six months after the events that led to the collapse of Bear Stearns, two Harvard Business School professors are working on a case that analyzes what happened during those eventful days of mid-March.

The case study, which is being written by Business School Professors Clayton S. Rose and Daniel B. Bergstresser, is expected to be taught jointly to the first-year finance and corporate leadership classes in April 2009.

“The events that led to the collapse of Bear Stearns represent one of the focal events in American financial history,” said Bergstresser, an assistant professor at the Business School and one of the case’s co-writers. “Until the market events of last week, the collapse of Bear was the major financial event of the last 10 years.”

In August 2007, two internal hedge funds, intended to take bets in the subprime mortage market, collapsed, despite being provided with $3.2 billion by Bear CEO James Cayne to bail out both the funds. After the collapse of the funds, Bear continued to lose money throughout the fall and winter, as the value of mortgage-related assets continued to deteriorate.

By March, matters worsened as perception on Wall Street caused financiers to stop providing the 85-year-old firm with new capital.

“They got into a situation where their financial policy relied on being able to rollover certain types of short-term financing,” said Bergstresser, who served as the former head of European Credit Research at Barclays Global Investors. “When the perception arose in the markets that Bear was having trouble, the fear of Bear’s failure became a self-fulfilling prophecy as Bear could no longer rollover their short-term financing.”

Rose added that the method of short-term financing became unsustainable as the credit crunch became overwhelming.

“It’s interesting to look back, seeing how the challenge for Bear was less about being undercapitalized than whether it had sufficient liquidity for everyday liquidity needs,” said Rose, who was the former head of the Global Investment Banking and the Global Equities Divisions at JP Morgan.

As the source of capital dried up, Bear was forced to attempt to sell off assets in order to increase its own capital and meet prescribed liquidity ratios. Ultimately, JP Morgan purchased Bear.

The Fed also agreed to take part in the deal during negotiations, providing a $30 billion backstop to help JP Morgan complete the deal.

Rose added that JP Morgan had to balance the risks of hidden liabilities with the potential for financial gain.

“JP Morgan faced a situation fraught with the risks and potential rewards that come with buying a company with $395 billion in total assets,” he said, “Were these assets valued at the right level, and if so, how much could the assets deteriorate by before becoming a big problem for JP Morgan?”

Rose also said that merging the two firms would present additional challenges.

“Talented employees will go elsewhere and clients who don’t want to deal with the turmoil will look to other firms to do business,” Rose said. “In addition, there are big cultural differences between Morgan and Bear, and solving these issues is a big exercise of time and attention.”

However, according to Bergstresser and Rose, the reasons to purchase Bear in the end seemed to outweigh the risks.

Both professors noted that Bear’s prime brokerage division and headquarters were attractive assets.

“In addition, it was clear that buying Bear was important to the financial system, and this weighed heavily on any decision,” Rose said.

“JP Morgan had the opportunity to potentially pick up businesses that were extremely profitable,” Bergstresser added, “but the question then and now is whether it was worth the risk that was taken on as well as the price paid for Bear. That remains to be seen.”