We celebrated two major market milestones last weekend - the fourth anniversary of the bull market and the 13th anniversary of the NASDAQ peak on March 10, 2000 - but there's one other important milestone I haven't seen celebrated in the major financial media outlets this week. Five years ago, on Friday, March 14, 2008, Bear Stearns suddenly collapsed and then died over the following weekend. From Wednesday, March 12, 2008 to the following Sunday, March 16, Bear Stearns' stock collapsed from $62 to $2 a share.
Bear Stearns was the first major domino in a series of financial failures in 2008. From October 2007 to March 2009, we saw a huge (55%) stock market decline in just 17 months, but oddly enough, the collapse of Bear Stearns had no major impact on the markets that March. The Dow and S&P were flat-to-gently-rising that week and for the month of March, even though Bear shares fell 97% in just a few days.
The Collapse of a Giant - the First Financial Domino of 2008
Bear Stearns' stock peaked at $172.69 per share in early 2007, when James E. "Jimmy" Cayne was CEO. In fact, Cayne became the first Wall Street CEO to own over $1 billion in his own firm. But he was a better bridge player than a CEO. He was off on a 10-day bridge tournament in Nashville when two Bear Stearns hedge funds failed in July 2007, and he was away on another bridge tournament in Detroit on March 13-14, 2008 when Bear Stearns was fighting for its life over a lack of liquidity. Bear's liquidity stood at $18.1 billion on Monday, March 10, but its cash reserve had sunk to $2 billion by March 13.
Bear Stearns' new CEO, Alan D. Schwartz, was off playing golf in a media event at the Breakers in Palm Beach, Florida when the crisis began, so it fell to 80-year-old former CEO Alan C. "Ace" Greenberg to try to stop the bleeding. On Sunday night, before the Asian markets opened on Monday, the Bear Stearns board had to accept a $2-per-share offer from JP Morgan Chase* or go bankrupt on Monday. A week later, a class action lawsuit lifted that offer to $10 per share. That's when Cayne sold the bulk of his shares for about $60 million - a 94% drop from their peak value, but he fared better than most other Bear Stearns employees and investors. CNBC later named Cayne as one of the "worst American CEOs of all time."
The Role of the Federal Reserve and U.S. Treasury in the 2008 Bailouts
The New York Fed, under the leadership of Timothy Geithner, was instrumental in brokering the Sunday night deal between Chase and Bear. A few weeks later, on April 8, former Fed Chairman Paul Volcker politely said that the New York Fed's actions "extend to the very edge of its lawful and implied powers," but the precedent was set that March for the rescue of troubled financial companies by federal agencies.
Six months later, in a similar weekend of sheer panic (September 13-14, 2008), Lehman Brothers was allowed to fail while the giant insurer AIG was bailed out. A stock market panic followed, which was mostly blamed on the failure to rescue Lehman rather than the $182 billion of taxpayer funds shoveled into AIG's coffers. The standard history lesson now says we can save the world by saving a big company (like Bear Stearns or AIG), or let the world collapse by failing to save a big firm (like Lehman Brothers).
With the Dow losing 18.2% in the week of October 6-10, 2008, Treasury Secretary Hank Paulson called seven major financial company CEOs into his office on October 8 and forced them to take $250 billion in TARP (Troubled Asset Relief Program) money, whether they needed it or not. TARP was later expanded to 16 financial firms and two of the Big Three car companies, receiving $296 billion in total transfusions.
From that day forward, "too big to fail" was upon us, and it hasn't ended yet. After the Treasury's TARP meeting, everybody had to be saved - GM, and a series of shotgun weddings among top financial firms. Eric Grover cited a few in this week's Barron's: "At regulators' urging, Bank of America* scooped up Countrywide and Merrill Lynch, Chase acquired Bear Stearns and Washington Mutual, and Wells Fargo* absorbed Wachovia." These many rescues seem to have "worked," with the eventual re-emergence of GM and AIG as stocks with rising market capitalization (now at $39 billion and $58 billion, respectively.)
Are our Biggest Banks Really "Too Big to Fail"?
Companies fail all the time. The only stock to remain in the Dow Jones Industrial index over the last 100 years is General Electric. If you look at the Fortune 500 or the Dow index from 50 years ago, you will be shocked to see how many big names from the 1960s no longer exist, while some of today's biggest names - like Apple, Google, Microsoft*, and Wal-Mart* - did not exist. Bill Gates and Steve Jobs were kids then.
Bankruptcy is the legal path for pruning dead wood from an economy. There is no reason why the biggest names in the financial field should be treated any differently than big names in any other industry. We shouldn't be afraid to let big financial companies fail any more than we feared the failure of big retailers like Woolworth, Montgomery Ward, or Borders Books. In bankruptcy court, the assets do not disappear. They simply migrate into the hands of new managers and owners - presumably more prudent owners.
The argument for "too big to fail" is that major banks and financial companies carry counter-party risks, which endanger several other corporations besides themselves. While true, this would seem to argue for breaking big banks up, rather than encouraging them to acquire little banks. It would also be important for investors to check out a company's financial solvency before using them as a major depository of funds.
Key Politicians are now Questioning "Too Big to Fail"
My point is not political or partisan. Both major parties have been operating from the same play book - rescuing big financial companies and car companies - but now, the political landscape may be changing.
In the last month, some influential voices have begun to question the "too big to fail" mantra. In a widely-viewed YouTube clip, Elizabeth Warren, the new Senator from Massachusetts, grilled regulators last month on their failure to prosecute financial crimes, saying in the end, "I'm really concerned that 'too big to fail' has become 'too big for trial.'" Then, on March 6, Attorney General Eric Holder echoed these views when he told the Senate that the "too big to fail" banks are "difficult to prosecute" for that reason.
The 2010 Dodd-Frank bill purported to end "too big to fail," but America's biggest banks are now bigger than they were before the crisis. Eric Grover wrote in Monday's Barron's that "Banks that are too big to fail are getting bigger. From 1995-2009, assets of the six largest banks increased from 18% of GDP to 68%. During the financial crisis, the top 10 banks increased their share of industry assets from 68% to 77%."
About a dozen banks are deemed "too big to fail," meaning that they are back-stopped by some branch of the government and thereby exempt from the normal and healthy economic process of making decisions based on business sense alone. This promotes risk-taking among these dozen banks, under the assumption that their golden parachutes are professionally packed when they choose to skydive with depositor assets.
None of this means we're in for another financial crisis or market crash. I've already written about how sound we believe this bull market remains (see February 14: "If the Market Hits a New High, is the Bull Market Nearly Over?"), but perhaps we need to be more selective at these lofty levels.
Research Note: There are at least five good books on the death of Bear Stearns, mostly written by leading financial journalists in the year after the event. The most gripping is Street Fighter: The Last 72 Hours of Bear Stearns… by Kate Kelly, then a reporter for The Wall Street Journal (now with CNBC). A wider-ranging analysis comes from Fortune's William D. Cohan, A House of Cards. In addition, former AIG CEO Maurice "Hank" Greenberg has just published his memoirs, The AIG Story. A better overview is Fallen Giant: The Amazing Story of Hank Greenberg and the History of AIG, by Ron Shelp and Al Ehrbar. These books tell the tale of a personalized attack on Greenberg by New York Attorney General Eliot Spitzer, resulting in a company that added "derivative credit swaps" to its core insurance business after the autocratic 80-year-old CEO Greenberg was forcibly ousted in 2005.
Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.