Stunning Bear Stearns Collapse Leaves Shareholders in the Lurch

Bear Stearns, once one of the biggest investment banks on Wall Street, was acquired by JP Morgan Chase over the weekend in an effort to salvage the failing institution.  The buyout of Bear Stearns by JP Morgan Chase – termed a “shotgun marriage” by some – was consummated after the Federal Reserve agreed to provide up to $30 billion in non-recourse financing to JP Morgan, with Bear Stearns’ illiquid mortgage and other securities as collateral.  When the dust settled, JP Morgan ended up buying Bear Stearns for a paltry $2.00 a share, a fraction of what it was once worth.

Left holding the bag are Bear Stearns stockholders.  Bear Stearns is being sold for just $236 million. The deal’s value is more than 90 percent below the company’s Friday closing share price of $30.85.  Earlier in the week, the stock had been selling for as much as $60 per share.  But even as the investment bank was crumbling around them, Bear Stearns executives maintained that the bank was solvent.

Already, Bear Stearns shareholders are exploring their legal options.  Shareholders might sue Bear and its executives and officers for securities fraud, contending they failed to disclose the company’s true financial health, lawyers say. Separate suits may be brought by Bear Stearns employees who hold company shares that are now virtually worthless

The collapse of Bear Stearns began last Tuesday, when financial markets began turning against the investment bank.  But the genesis of the crisis occurred when the housing bubble burst.  As home prices soared to economically unsustainable levels, fewer people could afford to buy. In response, banks and other lenders created new types of mortgages, which made loans affordable to people who normally wouldn’t qualify for a conventional 30-year mortgage. Banks and brokers collected fees for closing the deals but faced no risk once they sold the loans to Wall Street. Investment banks like Bear Stearns were enthusiastic buyers of  subprime loans, which they packaged with other types of debt into complex securities and sold to other investors.

Bear Stearns was one of the biggest underwriters of complex investments linked to mortgages. Two of its hedge funds, heavily invested in subprime mortgages, folded in July. Bear’s investors became increasingly reluctant to do business with the company. Despite the company’s assurances that it had plenty of cash on hand to continue operations, it collapsed Friday.

Because it was linked to so many other financial institution, the collapse of Bear Stearns threatened the already precarious financial markets.  The Federal Reserve was desperate to prevent a “fire sale” of Bear Stearns’ assets, which could have further depressed markets. For that reason, the Federal Reserve stepped in to mitigate the damage.  The Fed bailout included the $30 billion in non-recourse funding to JP Morgan.  Non-recourse funding means that if the collateral goes bad, the Fed can’t come after JP Morgan for other assets.  In the end, taxpayers could be on the hook for the Bear Stearns debacle.

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