Bear Stearns - The Tip of an Iceberg?

A couple of days ago one of my colleagues on the teaching staff came up to me and said that he was surprised to find so few people as worried as he was about the financial crises known as the credit crunch. He was spot on. Barely a day goes by without the Financial Times or the Wall Street Journal headlining news of the latest hedge fund collapse, bad debt write-off, profit warning from the real economy or rumours of a deeper and much broader contagion of disease ridden debt floating around the financial system. I was hinting to my economics class last week that things are likely to get worse - perhaps much worse - than the markets are predicting. Financial bubbles do not, as a general rule, deflate gently. Bubbles burst, and sometimes with frightening rapidity and force once euphoria has given way to doubt and panic. The massive injections of liquidity by the main central banks and the deep cuts in nominal interest rates are testimony to the seriousness of the credit crunch. They may not be enough.

So the news that the Federal Reserve has stepped in along with JP Morgan to save Bear Stearns, America’s 5th largest investment bank comes as no surprise. According to the Wall Street Journal “The (Fed) lifeline gives Bear access to cash for an initial period of 28 days. J.P. Morgan will borrow the money from the Fed and relend it to Bear…..It is the first time since the Great Depression that the Fed has lent in this fashion to any entity other than a bank.” There will be more of this to come.

Robert Peston, the BBC’s business editor argues that this was a “hedge fund run on an investment bank”. Whereas with Northern Rock, the stampede came from depositors wanting their money back, in the case of Bear Stearns, the catalyst for the point of near collapse came from a collective loss of confidence from the hedge funds that provided the bulk of the liquidity for the bank. Monday update: See also Robert peston’s blog article on the effect of “de-leveraging”

What we are seeing now is perhaps the tip of a singularly ill-concealed iceberg.

Sub-prime losses league table
(Courtesy of the BBC web site)

Citigroup: $18bn
Merrill Lynch: $14.1bn
UBS: $13.5bn
Morgan Stanley $9.4bn
HSBC: $3.4bn
Bear Stearns: $3.2bn
Deutsche Bank: $3.2bn
Bank of America: $3bn
Barclays: $2.6bn