Ten years ago this month, investment bank Bear Stearns was sold for $2 a share; Just the year before it had traded as high as $159. (The price was later increased to $10 a share.) This deal marked a watershed moment in what came to be known as the Global Financial Crisis, with repercussions later that fateful year, which continue to even this day.
Bear Stearns, a symbol of risk-taking on Wall Street, was overleveraged. An expansion of debt on and off its balance sheet along with involvement in the deteriorating real estate securitization market led to its collapse. Historically, such risk-taking was not only rewarded by markets, but also unofficially acceptable to regulators, as evidenced by the bailout of Long Term Capital Management in 1998. Fast-forward to 2008, when Bears Stearns and many of its peers were deemed “too big to fail.” More on that in the months ahead…
Now, after another 10 years, the end of Bear Stearns still holds valuable lessons for investors: liquidity should always be a critical objective even if risk-taking is rewarded over the long term. Systemic tools and processes to reduce tail risk cannot work in all environments. In fact, as any protection from market reality becomes systematic, it threatens the system itself.
Many investors, looking at multiple markets at or near all-time highs, are planning for dislocation and a chance to “buy low” after nearly 10 years of gains. Bear Stearns provides a cautionary tale that strategies need to incorporate constantly changing conditions that are never exactly like the past. Prudent risk-taking is based on assessing market opportunities while acknowledging what can go wrong. On a positive note, providing patient long-term capital in a downturn is one of the greatest benefits offered by institutional investors to the world economy.