Bear Stearns Collapse Costly to Many

Many people lost big money as Bear Stearns collapsed, among them British billionaire Joseph Lewis and Dallas-based money manager James Barrow. But employees may take the biggest hit. Collectively, they owned a huge stake in the bank.

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The collapse and takeover of Bear Stearns wiped out billions of dollars in shareholder value in a matter of days. The investment bank's employees were some of the biggest losers. But NPR's Scott Horsley reports that a number of large mutual funds also saw the value of their Bear Stearns holdings plummet.

SCOTT HORSLEY: Bear Stearns employees owned about 30 percent of the company's stock and there was a strong culture of employee buy-in. Today, those 14,000 employees are worried not only about their jobs, but also their savings. On Wall Street, it's not unusual for bonuses and retirement contributions to be paid in the form of company stock. Financial planner Greg Sullivan says the cliff dive that Bear Stearns share took is a painful reminder that bank employees should follow the advice they give clients and diversify.

Mr. GREG SULLIVAN (Financial Planner): Some of those people are going to have to start all over. Yet, people with not just a few thousand dollars of their wealth in there, but, you know, tens of millions - and these are smart, wealthy people that just went down financially. You know, they took a lifetime building it up and it just took a week for it to disappear.

HORSLEY: Some big mutual funds also lost big betting on Bear Stearns. Vanguard's Windsor II Fund owned millions of shares. Windsor II is a so-called value fund that looks for stocks that may be out of favor in the market and therefore, priced too low. Mutual fund analyst Dan Culloton of Morningstar says Windsor II's manager started buying shares of Bear last summer after the company reported trouble with two of its hedge funds that had invested in mortgage-backed securities.

Mr. DAN CULLOTON (Senior Fund Analyst, Morningstar): He thought it was cheap then and even bought more after former CEO James Cayne stepped down.

HORSLEY: That was just a couple of months ago when Bear's stock was still selling for as much as $90 a share. Like Vanguard Windsor II, Legg Mason value was another mutual fund that figured the price was a bargain.

Mr. CULLOTON: The idea was that a lot of the bad news was always priced into the stock as they saw it, and they saw a good franchise that they thought was going to come out on the other end of this thing. Obviously, that has turned out to be quite different.

HORSLEY: The sell-off accelerated last week as the price of Bear shares fell from $70 to just $30. By the time JPMorgan Chase swooped in to pick up the pieces, the price was down to just $2.

Mr. CULLOTON: And it's a very, very dramatic movement. But if you remember a few years ago, Enron unwound very quickly and there were a lot of managers who were caught holding the bag that time.

HORSLEY: Some disgruntled investors are looking for a way to recover what they've lost. The first class-action lawsuit has already been filed, and securities lawyer Peter Burke says he's heard from dozens of investors who believe they were misled.

Mr. PETER BURKE (Securities Lawyer): About five days ago, you have the CEO of Bear Stearns, Alan Schwartz, telling them that there's no problem with liquidity, they have a cushion, that there's nothing to worry about, and you have a lot of folks who are relying on that information. We've had an inquiry from one individual. He bought 2,000 shares on March 14th, he sold them today and he lost $56,000.

HORSLEY: If it's any consolation, CEO Schwartz's own investment in Bear Stearns lost about $28 million over the weekend. For most mutual fund investors, the loss is much more diluted. Morningstar's Dan Culloton knows there may even be some upside. Both Vanguard Windsor II and Legg Mason value have much bigger investments than JPMorgan Chase and those shares were up today.

Scott Horsley, NPR News.

BLOCK: Chances are, you still have some questions about Bear Stearns, the Federal Reserve, the credit crisis, or how all these things have affected the financial markets. If you want to know more, send us your question and put the words money question in the subject line. Later this week, we'll bring in some experts to help you get the answers. Once again, if you have specific questions about what's been happening in the world of finance, go to npr.org, click on Contact Us, then select ALL THINGS CONSIDERED and title your note, money question.

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Fed's Moves Highlight Fragile State of Markets

Stock traders negotiate in Sao Paolo Monday morning i i

hide captionStock traders negotiate in Sao Paolo Monday morning. Brazil's stock market dropped amid fears the global credit crisis that sank Bear Stearns would spread.

Stock traders negotiate in Sao Paolo Monday morning

Stock traders negotiate in Sao Paolo Monday morning. Brazil's stock market dropped amid fears the global credit crisis that sank Bear Stearns would spread.

Listener Q&A

It's no easy task to keep up with all the intricacies of the housing crisis, the credit crunch and the rest of the economy's doldrums. NPR's Adam Davidson and former Federal Reserve governor Laurence Meyer answer listeners' questions.

The Federal Reserve took dramatic measures over the weekend to reassure the increasingly anxious investment community, including negotiating the bargain-basement sale of Bear Stearns, one of Wall Street's biggest and most storied banks. The Fed's moves raise questions about just how deep the financial industry's woes go — and what other banks might be at risk.

Here, a look at what happened and what it means for the markets:

What was the Fed's role in the sale of Bear Stearns to JP Morgan?

The Fed extended JPMorgan Chase a $30 billion credit line to help it buy rival Bear Stearns, a firm with an 85-year history on Wall Street that was on the verge of collapsing due to losses in the mortgage market. JPMorgan is getting Bear Stearns for the rock-bottom price of about $2 a share — or about $236 million. That's a stunningly low price when one considers that Bear Stearns' shares were trading at $30 each on Friday, and that its company headquarters building in New York is valued at $1 billion by itself.

Why did Bear Stearns agree to be purchased for such a fire-sale price?

Bear Stearns really had no choice. The bank is facing an onslaught of rumors about its losses in the mortgage industry, and on Friday it reported some major liquidity problems — investors were pulling their money out and the bank was short on cash. The only way for Bear Stearns to keep doing business was to let itself be bought by another firm like JPMorgan. But the deal effectively wipes out most of Bear Stearns' shareholder wealth, and it's not clear whether it will win shareholders' approval.

What about customers of Bear Stearns? Will their investments be affected?

Bear Stearns customers will become customers of JPMorgan Chase. Their accounts will transfer automatically; they don't have to do anything, says Laurence Meyer, a former Federal Reserve governor.

What would have happened if the government had not stepped in and instead allowed Bear Stearns to go bankrupt?

Bear Stearns doesn't just have its own assets — it serves as what's called a "counterparty," meaning it works as the middleman for billions of dollars in transactions. So, working people have retirement funds there, for example, and smaller banks and hedge funds can trade stocks or securities through Bear Stearns.

If the bank did go bankrupt, an unbelievably long and complex legal process would begin. Thousands of Bear Stearns customers — from individual retirees to massive hedge funds — would have huge amounts of money just frozen. Imagine how complicated a personal bankruptcy is and multiply that by tens of billions of dollars in assets. The Federal Reserve wanted to avoid that.

What other measures did the Fed take?

Perhaps the Fed's most significant move over the weekend was the creation of a new program to give emergency loans directly to the 20 largest so-called "primary dealers." These are investment banks that do business directly with the Fed and which purchase the majority of Treasury securities.

In addition, the Fed lowered the discount-lending rate — that's the rate which it charges banks for very short-term loans — by a quarter-point, to 3.25, on Sunday. It followed that on Tuesday with a cut of three-quarters of a percentage point to another key interest rate, the federal funds rate.

Why did the Fed feel the need to take such dramatic action?

It's an indication of just how precarious things are in the financial markets. The fear is that if an investment giant like Bear Stearns fails, it could spark a run on other banks with sizable exposure to troubled credit markets, creating a domino effect of defaults.

Investment banks like Bear Stearns are the lifeblood of capital markets, providing the cash flow that keeps economic gears turning. They facilitate short-term loans to businesses, raise money for corporate expansions and IPOs and assist the trading of securities. Without them, financial markets would grind to a halt.

Does the Fed's intervention mean that things might be worse on Wall Street than they appear?

It certainly feeds those suspicions. The current credit crisis is largely being fueled by fear and uncertainty. Because they are not traded on a daily basis, mortgage-backed securities are difficult to value even in the best of times. Now that the mortgage market is in free fall, it's almost impossible to gauge just how much bad debt these banks have been left holding. That has made banks extremely nervous about making even short-term loans to each other.

Are other banks in serious trouble?

Yes, and everyone is asking who's most at risk. Some of the names mentioned most frequently are UBS and Lehman Brothers, both of which have a lot of exposure to subprime and mortgage-related securities.

Why do the markets feel comfortable with the Fed actions to help JPMorgan buy Bear Stearns, but not with government action to provide relief to homeowners who cannot pay their mortgages?

Actually, the Fed's action is quite controversial. "People do worry about moral hazard, although I think that Bear Stearns was significantly punished," says former Fed governor Meyer. The Fed has taken credit risk onto its portfolio that it wasn't really set up to do, but global investment banks are really too big to simply go out of business, he adds.

But when it comes to homeowners, it's important to understand that there are actions the Federal Reserve can take, and actions that the administration and Congress would have to handle. Helping out homeowners is up to the latter. "Again, there's moral hazard issues as to whether you should do that," Meyer says. "But the problem is so significant here ... I think you could reasonably argue that it is a time for [the Treasury Department] and the administration to put some taxpayers' money at risk here, in order to reduce the risks ... and help homeowners."

With reporting by NPR's Jim Zarroli, Chris Arnold, Adam Davidson and Uri Berliner

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