How Rich Big Bear became Poor Little Bear

12:06am Tuesday 18th March 2008


LAST Wednesday, Bear Stearns, with all the brass-knuckle arrogance with which it had always gone about its business, was still insisting its book value was around $84 a share.

By Sunday, with little more than a nod in the direction of due diligence, the US federal authorities decided it was bust and muscled it into a shotgun takeover by Wall Street rival, JP Morgan Chase. The price? Just $2 a share. And that sweetened by $30bn of guarantees, underwritten by the US Federal Reserve - proxy for the American taxpayer - over the dodgier assets on Bear Stearns' books.

This high-speed fire-sale left one of Bear's largest individual shareholders, former chief executive James E Cayne, nursing a massive financial loss. Little more than a year ago, when Bear stock was trading at nearly $172, his personal stake was worth around $1.2bn. Now it's valued at just $13.4m.

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Cayne can console himself that, through the fat years, he took home more than $232m in salary, bonuses and other perks. A lot of the investment bank's 14,000 employees won't be quite so lucky. Collectively they own 30% of the business. The value of that stake has now been shredded. Many will also pay with their highly lucrative jobs.

But that's just the start of it. The demise of America's fifth-largest investment bank, like the collapse of assorted hedge funds and the crisis at Northern Rock before it, could be just a taster for much grimmer fall-out to come.

Fall-out that could push many non-financial companies around the world to the wall as commercial lending dries up. A main course that makes it much harder for ordinary families, on both sides of the Atlantic, to borrow enough money at affordable rates to buy a new home or even maintain their existing lifestyle.

It is easy to characterise these early casualties in this latest financial trauma as reckless fat cats getting their deserved comeuppance. But, as what is arguably already the worst such crisis of the post-war era continues to unravel, the impact on life as we know it could prove deeply damaging to the prosperity of millions of unsuspecting citizens.

As bank valuations around the world plummeted in recent months, much of the initial talk was about picking the right moment for investors to wade back in and make a killing. Royal Bank of Scotland at 300p a share? HBOS at 450p? Might that be the time to fill your boots?

But such is the mood of mistrust and incipient panic this time around, such is the continuing paralysis in credit markets, darker thoughts are now intruding. Might the crisis be qualitatively different this time around? Does banking as we now know it - without radical reform and better regulation - have any long-term future?

Or has the sector strayed so far from its prudential roots - taking deposits from savers on the one hand, profitably lending that money to borrowers on the other - that the current model is irreparably damaged? Has this generation of bankers built an edifice of dazzling scale and profitability, but one that has grievously misread the risks built deep into its foundations?

All banks, including the big retail names, now routinely repackage many of their liabilities and sell them on. Do you know who the ultimate beneficiary of your outstanding mortgage is? Such spreading of risk is routinely reciprocated by banks. But did they ever consider what might happen if the pass-the-parcel suddenly stopped and some players were left holding duff packages?

Liquidity was all. Readily available interbank borrowing, at keen rates, enhanced that liquidity and banished to the recesses of banking history the days of mortgages on allocation or rationing of credit. But this flight to complexity came to a juddering halt last autumn as the sub-prime crisis in America and the near-demise of Northern Rock here raised countless unanswered questions.

Did the financial engineers who thought you could repackage high-risk mortgages to America's poor into AAA-rated securities ever stop to think what might happen when the interest rate cycle turned and the poor could no longer afford their monthly payments?

Did the board of a North of England mutual, turned quoted bank, ever think, as they sanctioned the pursuit of hell-for-leather market-share growth, what might happen if the money markets ever seized up? Did the tyros at Bear Stearns, chomping on their cigars and boasting about how far they could test the trading envelope, never think: This is banking, not alchemy.

Well. Now these risks have all crystallised, to such devastating effect, the great unanswered question is how many more lurk in all those off-balance sheet vehicles and investments made in times of plenty. Governments are not in control of this great unravelling. Slashing interest rates is not the answer when the problem is banks refusing to lend at all except at punitive margins.

The main issues now are how many more Bear Stearns will bite the dust before this firestorm finally blows itself out? And at what cost in government bail-outs and wider economic fall-out?


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