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How hedge funds sank Bear Stearns

• Robert Peston
• 14 Mar 08, 08:52 PM

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.

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America's Northern Rock

• Robert Peston
• 14 Mar 08, 02:42 PM

demonstrates that the worst of the global credit crunch is not yet behind us.

As an incident, it is America's Northern Rock.

But the run on Bear Stearns hasn't been a run of small savers, as happened at the Rock.

There has been a wholesale run on this leading investment bank, a withdrawal of capital by leading financial institutions.

Bear Stearn's creditors have become progressively concerned about Bear's exposure to mortgages - not subprime mortgages but AAA good-quality home-loans.

Why? Because on a daily basis there's been more and more disturbing news about the deterioration in the US housing market and the difficulties faced by borrowers in repaying their debts.

This is what did for Carlyle Capital Corporation earlier this week. And it meant that in just the last 24 hours Bear Stearns came close to running out of the cash or liquidity it needs to meet its daily requirements.

So enter the New York Federal Reserve. It is promising to supply whatever liquidity is required by , the leading bank, to help Morgan provide whatever funds are required by Bear Stearns.

Since JP Morgan is saying there is no risk to its shareholders, this represents a central bank bailout of Bear Stearns

So, as I say, this is America's Northern Rock.

UPDATE 16:40: A bit of context on Bear Stearns.

First, please don’t overstate the analogy with Northern Rock. Bear Stearns is an investment bank at the heart of Wall Street. It is not a retail bank like the Rock.

Second, it is – like the Rock – what regulators classify as a high impact firm. Or to put it another way, it is too big to fail.

Why? Because its businesses had consolidated assets $395bn at the end of November 2007 – which would make it roughly twice the size of Northern Rock.

If it had gone down, and there had been a fire sale of assets, there would have been a double whammy for the financial system.

First, there would have been losses for those institutions and individuals that have provided $383bn of credit to the various bits of Bear Stearns (there was also $12bn of equity supporting all that debt).

Second, the market price of all sorts of financial assets would have collapsed. And that could have caused solvency and liquidity problems at other banks and financial institutions.

So the New York Fed had no choice but to rescue Bear Stearns.

What’s unclear is whether the main problem at Bear Stearns is – like it was at the Rock – mainly one of technical insolvency caused by an inability to raise finance.

Or whether there is already a deficit between the value of Bear Stearns’ assets and its liabilities.

The trigger for the rescue of Bear Stearns was that the liability side of its balance sheet has gone wrong; it is in danger of running out of cash to fund itself.

But are its assets of reasonable quality?

As of November 30, it had $46bn of exposure to mortgages. And it is a fall in the market-value of mortgage-backed securities that has spooked Bear Stearns’s creditors.

The big question is whether creditors’ anxiety is hysterical or rational.

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Banks: Too private?

• Robert Peston
• 14 Mar 08, 10:05 AM

When a chairman or chief executive appears on ´óÏó´«Ã½ television or radio, he or she is typically talking to millions of people in the UK and across the globe via our assorted programmes and channels and platforms.

That’s appealing to a minority of business people, such as of or of . Their visibility, they believe, sends out a strong message of confidence in their respective businesses to their customers, employees and shareholders.

Other executives are more reclusive, they cherish their privacy – which is understandable.

It’s part of my job to persuade them they have a duty to be accountable, via the ´óÏó´«Ã½, to the many different groups which have an interest in their respective companies.

As the power of global companies is perceived to be increasing, it is arguable that those who run them have a greater responsibility to explain themselves in public forums.

Even if a chief executive insists on sticking to the traditional view that it’s only shareholders that really have the right to put him or her on the spot, those shareholders are the many millions of us via our pension funds.

And in an era when media is fragmenting, there are few more public spaces than appearing on the ´óÏó´«Ã½.

That said, broadcast interviews are scary – especially if it’s not just the interviewee’s reputation which is at stake, but that of a big business with thousands of employees and subject to brutal competitive forces.

However those who have fought to the top of big organisations are normally pretty good at presenting themselves and dealing with difficult questions. For all the anxiety of business people about appearing on TV or radio, I can’t think of a single one who has been damaged by the experience in the two and a bit years since I joined the ´óÏó´«Ã½.

There are times when I am genuinely surprised by the reluctance of executives to appear on television or radio.

For example, the chief executives and chairmen of almost every bank refused to do interviews with any broadcaster over the past few weeks when each bank was disclosing its respective financial performance for the previous year.

It was a big moment for all of them, because of the massive swing in their fortunes caused by the credit crunch.

I had assumed that – on the Stuart Rose model – they would want to appear on television and radio to reassure their customers and shareholders at a time of high anxiety.

I was wrong: , , and all said no.

Their senior executives were happy to talk off-camera or away from a microphone. They were happy to be intermediated by me. But they didn’t want you, the viewer and listener, to hear their voices and see their faces.

There was a notable exception: , chief executive of , gave a to me which went out on TV and radio.

I think that reflects well on Barclays – but I have a vested interest in thinking that.

What are your views on all this?

I asked a couple of bank bosses why they and their teams were being so shy.

The reason they gave was that conditions in money markets remain exceptionally difficult, the confidence of bankers remains fragile, and the outlook for their businesses is hugely uncertain. And in those circumstances they and their executives have to weigh their every word with care.

Given that they can’t yet predict all the consequences of the unwinding of years of excessive lending, they are fearful of talking to millions of people through a medium (viz, the ´óÏó´«Ã½ or any broadcaster) they can’t control.

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