How hedge funds sank Bear Stearns
Bear Stearns was taken to the very brink of insolvency over the past 24 hours by a sudden collapse in confidence on the part of its hedge-fund clients.
There was a wholly modern hedge-fund run on the investment bank.
Here’s how it happened.
One of Bear Stearns’s most profitable businesses was its prime brokerage, which provides lending and admin services to hedge funds with a fixed-income bent.
These hedge funds deposit their assets at Bear Stearns, which the investment bank uses as a source of liquidity.
But – according to a banker close to Bear Stearns – in the last day or so a number of those hedge funds decided to terminate their respective relationships with Bear Stearns.
They were spooked by the rampant speculation about Bear Stearns’ fragility and its supposedly excessive exposure to US mortgages.
The hedge funds stampeded to withdraw their assets, so the investment bank was deprived of a vital source of liquidity.
That’s why it had to go cap in hand to the New York Fed for financial succour.
Perhaps the most shocking aspect of this episode is that help was in sight for Bear Stearns at the very moment the hedge funds pulled the plug.
As of March 27, Bear Stearns would have been able to exchange its illiquid holdings of mortgage-backed securities for high-quality, liquid US Treasuries, under a scheme announced last Tuesday by the US Federal Reserve.
That would have provided Bear Stearns with sufficient liquid funds to continue as a going concern.
But its hedge-fund clients weren’t prepared to stick with it even for 13 days.
It’s a very frightening manifestation of the nervousness of even sophisticated investors such as hedge funds.
In today’s highly uncertain markets, they are not prepared to give an 80-year-old Wall Street firm the benefit of the doubt for even a fortnight.