Bear Stearns Lost $10bn in Just One Disastrous Day, Admit Top Officials

The breakneck speed at which Bear Stearns went bust became clear yesterday as American lawmakers heard that more than $10bn (£50bn) of the 85-year-old Wall Street investment bank's financial liquidity evaporated in a single disastrous day.

Top officials from the Federal Reserve and the Securities and Exchange Commission told the senate banking committee that they were forced to step in with a $30bn public guarantee to prevent an "abrupt and disorderly" bankruptcy from threatening America's financial stability.

Christopher Cox, chairman of the SEC, said regulators had been encouraging Bear Stearns to bolster its capital since two of the bank's hedge funds collapsed in June last year. Under pressure from the SEC, the bank upped its cash resources from $8.4bn at the end of January to a peak of $21bn at the beginning of March. As rumors of problems at Bear circulated in the market, this sum quickly declined and, on March 13, the bank's liquidity dived from $12.4bn to just $2bn prompting a distress call for emergency help.

"There was a complete evaporation of confidence and a refusal by counter parties to deal," said Cox, who agreed with a suggestion that Bear suffered a run on the bank. "Although we're not accustomed to using that term in the investment banking sphere, the analogy is nearly complete."

When asked by senators whether unscrupulous "short selling" by speculators contributed to Bear's collapse, Cox made it clear that the SEC was investigating. "The SEC very aggressively pursues insider trading, market manipulation and the kinds of illegal naked short selling that have been very publicly alleged in this case," he said. In negotiations concluded around the clock as Bear Stearns was running out of cash, rival investment bank

JP Morgan agreed to buy the firm, but only if the Fed's New York branch stood behind $30bn of its riskiest assets.

Several senators expressed skepticism over the wisdom of this use of public money. Jim Bunning, a Republican from Kentucky, accused Fed chiefs of ignoring repeated red flags in the development of the sub-prime mortgage crisis which led up to Bear's failure.

"How did we get to a point where the failure of one firm can bring us to the edge of collapse for the whole of our financial markets?" Bunning asked. "How did you let the financial system become so fragile that it could not tolerate one failure?"

The New York Fed's president, Timothy Geithner, answered that it had taken years to develop: "What produced this is a complicated mixture of factors. I don't think anyone fully understands it yet."

Fed officials said a substantial increase in risk-taking, the invention of elaborate derivatives and a deterioration in underwriting standards contributed to the financial system's brittle condition. Geithner said regulators tried to crack down on the problem, but added: "I'm not claiming people were wise and all-knowing or that we did everything that could have been done."

Officials confirmed during the hearing that the Fed and the US treasury put pressure on JP Morgan to keep down the price of its takeover offer for Bear Stearns in order to avoid the "moral hazard" of shareholders being compensated for their investments in a failed enterprise.

Robert Steel, the treasury under-secretary for domestic finance, said the treasury was "actively involved" in negotiations and made it clear that "a lower price would be preferable".

"There was a view that the price should not be very high, that it should be towards the low end," Steel said.

The strategy backfired because JP Morgan's initial deal to buy Bear at $2 per share aroused such outrage among shareholders that it was raised to $10 a week later.

In written testimony, JP Morgan's chief executive, Jamie Dimon, said it would have been too risky to buy Bear without the Fed's backing: "This wasn't a negotiating posture. It was the plain truth." The alternative, Dimon wrote, was a bankruptcy which would have touched off a chain reaction of defaults at other financial institutions.

"It could have made it harder for home buyers to get mortgages, harder for municipalities to get the funds they need to build schools and hospitals and harder for students who need loans to pay tuition," Dimon told Congress.

Bear Stearns' chief executive, Alan Schwartz, told the committee that he had salvaged what he could on behalf of the bank's shareholders, bondholders and 14,000 employees and that a bankruptcy would have been "devastating" for the financial markets. "It may have triggered a run on other investment banks, with potentially disastrous effects on the nation's economy," said Schwartz in a written statement. "Like all of us, I am certainly glad such a disaster did not occur."

Number crunching

$30bn The sum the SEC and the FED had to publicly guarantee to save the bank

$2 The amount per share JP Morgan originally offered; it caused outrage

$10 JP Morgan's per-share offer made a week later after shareholder protest