bear stearns case

These actions led to the fall in prices of securities. Loans were liquidated and borrowing from banks and other lenders became difficult. Interest rates would rise rapidly and sharply. This type of financial hardship led to the liquidation of bank credit. Over a long enough span, this liquidation would lead to money crises (Federal Reserve System 5th ed pp. 10-11).

The outbreak and spread of the financial crisis of 2007-2008 have caused the most of countries into severe economic difficulties and also created an adverse impact on the global economy. The beginning of the financial crisis is defaults in the subprime mortgage market in the USA. Although the global economy seems to recover since 2009, the impacts of the crisis still affect many countries until now. This essay focuses on the background and impacts of financial crisis, and the learning from the movie The Big Short.

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

A Colossal Failure of Common Sense was one of many books to be published in the aftermath of the Financial Crisis of 2007. After seeing the global economy stall in the face of massive losses in word financial markets, many Americans sought to better understand the crisis and its causes. This book, written from the perspective of a financial market insider, provides a glimpse into the world of global finance and also seeks to explain how the players in this world were involved in the crisis. In the words of the author Lawrence McDonald, “My objective in writing A Colossal Failure of Common Sense was twofold. First, to provide … a close-up, inside view of how markets really work…..And, second, to give… as crystal clear an explanation as possible about the real reasons why the legendary Lehman Brothers met with such a swift end”1. By writing about his personal experience at Lehman Brothers and recounting stories from within the famous investment banking firm, Mr. McDonald largely succeeds at his first goal. However, the elements of personal biography and the chronological order of the book make it difficult for the reader to fully appreciate all of the varied causes of the financial crash. I believe that the main value of reading this book is in understanding these causes, with Lehman Brothers acting as a microcosm of the greater financial universe. As such, in this review I have isolated elements from Mr. McDonald’s book which highlight how the crisis

“The Fed did not bailout Bear at taxpayer expense, but enabled – as it is mandated – the financial markets to continue to function. History will call the Fed’s action the right move at the right time”, says Jeremy Siegel, Ph.D. The Bear Stearns Company began a financial meltdown in July 2007. By March 2008, it was ready to file Chapter 11 bankruptcy. Some people believe that the Federal Reserve should not have stepped in to bailout Bear Stearns because it was rewarding reckless business behavior and Bear should have been left to file bankruptcy. The deal of Bear Stearns was not a government bailout; it was rather a loan to preserve jobs, homes, savings, the economy, the shareholders of Bear, and the financial

In 2008 the United States economy faced it most serious economic downturn since the great depression. This crisis began in 2006 when the subprime mortgage market showed an increase in mortgage defaults. This would lead to the decline of the U.S. housing market after a decade of high growth. The problems in the mortgage market where able to spread to other sectors of the economy especially in financial markets because of Collateralized Mortgage Obligations or CMOs. CMOs where mortgage backed securities that where given out by investment banks and where not regulated by the government. These securities fell as did mortgages due to increasing default rates. Because of CMOs companies bought Credit Default swaps or CDSs. These CDSs where nominally

Bank of America, under the impression they had made an excellent business decision was unaware of the totality involving Countrywide’s loan practices. Only a small group of Bank of America’s employees were involved in the assessment of Countrywide’s books and operations techniques, yet had no input in the acquisition (Rothacker, 2014). Only a matter of time, Bank of America would realize the magnitude of legal issues it had acquired from Countrywide. However, Bank of America, which was much larger, had the ability to manage the negative media and confront the rising legal troubles better than Countrywide. Ironically, in 2001, Bank of America discontinued subprime mortgages and higher priced loans to riskier consumers (Rothacker,

Once the US housing market collapsed, it created a credit crisis and crunch in the wider financial markets. Due to the complexity of CDOs many people had no idea how much they were really worth. Many of the CDOS were worthless and it was almost impossible to find the value of them (7). This led to a moral hazard problem whereby there was an overall caution of banks because many had no idea if they were even bankrupt. Inevitably, the interbank lending system crumbled whereby some banks stopped lending to each other and to corporations altogether or only lent with very high interest rates. Many banks who relied on interbank lending for money were heavily affected by this including Northern Rock. Inevitably, depositors of these banks become dubious of their banks financial situation and were provoked into withdrawing their money.

CDSs are used as an insurance against the possibility that the borrower could not repay his or her loan. In such case the issuer has to pay a specified sum to the buyer. Of course they are sold for a premium and if no credit events occur, the issuer makes profit. After the subprime mortgage crisis began, and many borrowers started defaulting on their loans, the pressure on the companies that had issued CDSs was rising. There were companies that simply did not have enough money to repay everything they owed. A famous example is AIG. The subprime mortgage crisis and the bankruptcy of big financial companies, like Lehman Brothers, meant that AIG had to pay much more money that it expected and made the company insolvent. The company itself had AAA rating shortly before this. This made the investors confident that even their high-rating investments failed, the insurer would certainly be able to repay them. A bailout from the US government followed. Generally, the issuers of these instruments can be held accountable for issuing them, without the ability to pay what they had to, when the credit events occurred. Of course many of them were mislead by the credit rating agencies and the overall conviction in the market that it was not as risky as it actually was. Many people argue that such instruments need to be regulated much better. They can create clear conflict of interests. For example, a

“The single greatest contributor to financial crises is the Federal Reserve manipulating interest rates in ways that distort the true price of capital.” (Kibbe, 2011) The distortion of numbers created a false sense of overinvesting when in actuality they are responding to false economic signals. Just like the Great Depression, the stock market was not the only thing that was effected, unemployment doubled and debt rose from 66% to 103%. The housing market also took a hit falling 30%.

The nation’s central bank, the Federal Reserve, backed the loan helping to prevent the collapse of Bear Stearns and to stabilize the financial market. The Federal Reserve and JP Morgan Chase extended an immense line of credit to help Bear Stearns stay afloat. In a matter of one-week Bear Stearns went from $70 to $2 a share. The Federal reserve, JP Morgan Chase and Bear Stearns pulled off what usually would take months, took only a weekend before the market reopened on Monday. Ultimately, selling Bear Stearns to JP Morgan Chase for $2 a share (Greenberg and Singer, 2010).

The scandal evolved when banks exploited mortgage securitization and packaged Mortgage Backed Securities (MBS) and Residential Mortgage Backed Securities (RMBS) in an unfair manner, and were sold off to investors around the world who were manipulated to think they were investing in not the best of quality credit risk loan, but really they were investing in subprime loans that were essentially worthless. As a result, investors lost billions of U.S dollars; due to the widespread effects other loan markets were affected which led to a loss in investor confidence in the United States financial markets; the United States housing crisis meltdown and ultimately the 2008 financial crisis (BARRETT, D. AND FITZPATRICK, D. 2013).

Collateralized debt obligations (CDOs) refers to a kind of innovative derivative securities product which simply bundling mortgage debt, bonds, loans and other assets together and then rearranging these assets into different tranches with different credit ratings, interest rate payments, risks, and priority of repayment to meet the needs of different investors. As borrowers began to default, investors in the inferior tranche of the CDOs took the first hit, so the owner of this tranche of CDOs may be riskier. In order to compensate for the higher risk, the subordinate tranche receives higher rate of return while the superior tranche receives lower rate but still nice return. To make the top even safer, the banks ensured it small fee called the credit default swap (CDS). The banks do all of the works so that creating rating agencies will stamp the top tranche since as a safe, triple A rated

At the height of the 2008 financial crisis, Mr. Lawrence G. McDonald wrote a book on the fall of Lehman Brothers, entitled "A Colossal Failure of Common Sense." This book is a risk manager 's guide to the right and wrong moves on Wall St., and explains why investors must stay ahead of policies coming out

There has been a debate for years on what caused the Financial Crisis in 2008 and if there was one main cause, or a series of unfortunate events that led to the crisis. The crisis began when the market was no longer funding many financial entities. The Federal Reserve then lowered the federal funds rate from 5.25% to almost zero percent in December 2008. The Federal Government realized that this was not enough and decided to bail out Bear Stearns, which inhibited JP Morgan Chase to buy Bear Stearns. Unfortunately Bear Stearns was not the only financial entity that needed saving, Lehman Brothers needed help as well. Lehman Brothers was twice the size of Bear Stearns and the government could not bail them out. Lehman Brothers declared bankruptcy on September 15, 2008. Lehman Brothers bankruptcy caused the market tensions to become disastrous. The Fed then had to bail out American International Group the day after Lehman Brothers failed (Poole, 2010). Some blame poor policy making and others blame the government. The main causes of the financial crisis are the deregulation of banks and bank corruption.