Shareholders in Bear Stearns have been all but wiped out despite the rescue bid from the Federal Reserve and JP Morgan Chase, prompting comparisons to the collapse of Enron. CNBC has been airing videos of old interviews with former Enron CEO Ken Lay, which fell apart almost seven years ago destroying a great deal of shareholder value. Far more shareholder value, in fact, than at Bear Stearns.
Those comparisons are apt, Tom Kirkendall points out, but not for the reasons many would suspect. There’s a tendency among some—especially plaintiff lawyers and some in the media—to suspect criminal wrong-doing when a company collapses. How could so much value be destroyed without serious wrong-doing? But these suspicions are often wrong-headed, and may even be counter-productive if they encourage shareholders and regulators to concentrate on investigations or misguided regulations.
Kirkendall says that the risk of collapse from a loss of investor and customer confidence is inherent in the kind of businesses that both Enron and Bear Stearns ran.
The fact of the matter is that Enron was -- and Bear Stearns and AIG are -- trust-based businesses that fundamentally depend on the trust of the markets to sustain their value. Once that trust is lost, such companies lose value quickly and dramatically (a case in point -- JP Morgan Chase's proposed $236 million purchase price for Bear Stearns comes just hours after Bear's market cap was $3.5 billion this past Friday and $20 billion as of January, 2007) Although unfortunate for the owners of such companies, such a dramatic loss of wealth does not necessarily mean that any criminal conduct caused or was even involved in the loss. Rather, such loss is simply one of the risks of investing in a company based on a trust-based business model. The sooner we all recognize and understand this risk -- and avoid the mainstream media's promotion of myths about them -- the quicker we can put a stop to injustices such as this while advancing the discussion of how best to hedge the risk of such potential losses.
That pesky trust-based business model [Houston's Real Clear Thinkers via Ideoblog]
Posted by guest , Mar 17, 2008 1:08PM
Its amazing that so many so -called "Masters of the Universe" have let this happen. Ruining tons of peoples lives, wiping out their retirement, etc. Meanwhile Cayne is buying 30 million dollar apartments. Anyone hearing anything about Lehman by the way, not lookin good for them right now.
Posted by guest , Mar 17, 2008 1:10PM
By the way, amongst all the BSc stuff did anyone notice Deutsch Bank have suspended some FX traders for ``procedural errors'' on its currency desk?
Posted by guest , Mar 17, 2008 1:12PM
That is what happens when a company blocks dealbreaker.
Apparently MER has blocked it as well. Does that mean MER has liquidity problems?
Posted by guest , Mar 17, 2008 1:13PM
the trust based business model would be improved if companies were required to have the full extent of their business carried on their books. The second point this brings up is the US Treasury steps in and provides some type of credit support for JPM. Any PE firm doing this deal would get some type of upside. Why isn't the treasury cutting itself a deal on our behalf?
Posted by Anal_yst , Mar 17, 2008 1:16PM
@ 1:08
the so-called 'masters of the univ' of which u speak own/owned 30% of the company, so not only are they losing their 'retirement' money, but likely their jobs as well.
Posted by guest , Mar 17, 2008 1:22PM
There goes Lehman........
Posted by guest , Mar 17, 2008 1:28PM
"Trust and strength" are the first refuge of financial scoundrels.
Posted by guest , Mar 17, 2008 1:35PM
No Tommy Boy, it's not all about trust - it's about DUE DILIGENCE. If Tyrone is making $30,000 and you lend him $300,000 (or trust him), you as the lender are completely moronic to trust him if you had done your due diligence. Yes, you have to trust that Tyrone can keep his job at Chicken Shack and that his eight bedroom house will APPRECIATE in value, but somebody forgot to use their COMMON SENSE! From $20 BILLION to $238 million in two months? No criminal activity at all. Just a normal 'mistake' or 'miscalculation'. Perfectly normal! Bush sez the economy is GREAT! Happy Days are here!
Posted by NotNasser , Mar 17, 2008 1:36PM
The comparison between Enron and Bear itself suggests another comparison -- between Dynegy and JPMorgan.
Remember? In the fall of 2001 Enron thought it could avoid bankruptcy by selling itself at what seemed like a fire-sale price to its cross-town rival.
That deal began unravelling as soon as the ink dried. Perhaps sooner.
Hmmmmm.
Posted by guest , Mar 17, 2008 1:47PM
I worked at Bear - but left a few months later after realizing what a staggering mistake I had made. The senior management at that company has to be absolutely the worst bunch that I've ever worked around. It was simply unbelievable, and I couldn't imagine how an outfit could stay in business as long as it had with that kind of crew in place.
The lousy senior management was a direct reflection on the poor quality of management at the top - allowing those kinds of non-performers to stay in place for 10, 15, 20 years...
It's definitely time to break out the handcuffs - people are going to jail on this one, for sure. It couldn't happen to a nicer bunch.
Posted by guest , Mar 17, 2008 1:51PM
Yes, when is the class action suit starting. Sign me up.
Posted by guest , Mar 17, 2008 1:59PM
I'm curious as to what wrongs you are seeking to be compensated for through a class action suit.
Posted by guest , Mar 17, 2008 2:03PM
"Trust" is based on management's ability to meet its fiduciary duties.
Posted by guest , Mar 17, 2008 2:05PM
Hey 1:59 -
How about Schwartz publicly announcing that the firm was A-OK a few days ago? If there isn't a lawsuit in that then the plaintiff's bar and the SEC might as well pack it up, too.
Posted by guest , Mar 17, 2008 2:25PM
I don't know why it is so hard for people to understand that a bank can be sufficiently capitalized for normal operations but could not withstand a run on the bank. A bad enough run can destroy a bank in a single afternoon. Unless there's more underlying problems, there's no class action for damage caused by a run. It's part of the risk one assumes when one buys a bank stock.
Q. Weren't people paying attention in American history when they taught about Franklin Roosevelt, bank runs, and bank holidays?
Posted by guest , Mar 17, 2008 2:31PM
Poor Carney. You know, a pyramid scheme is also a trust based business. It will keep chugging, people will keep making money, until confidence in the magic of the pyramid for creating wealth is lost.
As ever, the Carney is uniquely deprived of insight. The question is not whether businesses require the confidence of stakeholders to function, but whether a given business model can sustain confidence. Debt fueled profits work fantastically until the negative cash flows outstrip the new financing on tap. the timing of that moment varies, its occurance never does. It is this way in which Bear Stearns echoes Enron and in which they both echo confidence schemes as old as the hills.
-one synapse clapping
Posted by guest , Mar 17, 2008 2:33PM
A: because the second part of the lesson was the SEC act, FDIC insurance, Glass Steagle, tightened margin requirements, etc., leading most to conclude that it such occurances were a thing of the past.
Posted by BSD , Mar 17, 2008 2:35PM
How about Cramer, still-battered from the Spitzer fallout, recommending that nobody get out of Bear?
http://www.businessandmedia.org/articles/2008/20080317110946.aspx
Posted by guest , Mar 17, 2008 3:16PM
@2:25 I happened to be at a Chase bank branch this weekend and it was PACKED. I'm not saying that a run on banks is occurring, but I'll just say I wouldn't be too optimistic on bank stocks. Add this:
http://www.youtube.com/watch?v=CnnOOo6tRs8
and a Hoover-esque El Presidente and it's 1929 all over again! All we need now is WWIII to get us out! Pakistan, Russia, China and Iran - ya listening? Bring it on!
Posted by guest , Mar 17, 2008 3:54PM
@2:33pm. I realize that there were plenty of reforms in the New Deal after the bank insolvencies. Didn't most of the runs in the Depression happen to retail banks? Bear Stearns is an investment bank. I don't think the FDIC applies to it, I don't know what would difference Glass Steagle make in this context, and tightened margin requirements, while a good thing, don't necessarily prevent a bank run. I was bringing up the historical bank runs to illustrate how devastatingly fast a bank run can happen, how hard it is to protect a bank once it does happen, and how ruinous a run can be.
"Bank run" was used in the same sense any catastrophe would be, such as "flood" or "hurricane." Obviously, there are steps you can take to control losses from floods and hurricanes, but they still can occur and are devastating when they do. Same thing with a bank run.
This period of time has shattered two myths: housing prices don't fall, and bank runs can't happen anymore.
Maybe there's an underlying class action for what happened with Bear Stearns, but I'm skeptical that shareholders can recover for the effects of a panic.
Posted by guest , Mar 17, 2008 4:14PM
@1:35
It's offensive that you use "Tyrone" working at "Chicken Shack" as an example of subprime problems. He has to hold down the "job" at Chicken Shack because "LaKeisha" needs another "weave" so she looks "ghetto fabulous" while classily sipping that "forty". Mmm hmmmm!
Posted by guest , Mar 18, 2008 9:26AM
"such a dramatic loss of wealth" wouldn't it be more accurate to say "such a dramatic transfer of wealth"?
Posted by guest , Mar 18, 2008 5:36PM
My business is misunderstood but also is fundamentally trust-based. You can see me anytime and get your full money back. No, you can't see my books, but the fine accountants I pay for will tell you my financial ratings are AAA, and I pay for insurance from some fine companies. However, you must get in on the deal right now as the market is going up rapidly and once you and your friends are in the value will increase forever, trust me --Charles Ponzi
Posted by guest , Mar 18, 2008 11:27PM
How was Bear Stearns to know that risky investment in mortgage-based securities in the midst of a massive and irrational asset bubble, purchased with massive amounts of "leverage," could result in a massive liquidity crisis?
Especially after the great performance the company delivered in 2007, earning likely HUGE sums in bonuses.
I mean, surely the crisis was a shock to everyone and likely hit late on Friday. It was completely unexpected for everyone, and there was nothing to indicate that there was a risk of anything other than eye-popping profits for all eternity!
Posted by guest , Mar 18, 2008 11:28PM
It's true that the original J.P. Morgan testified to Congress that he valued character (trust) more than anything else (such as I suppose Greenspan's econometric risk models now disavowed).
And Robert Shiller has suggested some interesting ideas about the housing market and stock market: it seems the accusations of fraud (and thus lack of trust) usually come AFTER the crash, as a sort of post-facto emotionally satisfying narrative of what people would like to think caused the event, surely not their own greed and fear but rather blame it on others, they get out not because of some rational assessment of supply and demand in the market but rather to avoid the embarrassment they see others endure.
In another exercise of behavioral (cognitive) economics, Harvard professors such as Iris Bohnet have proposed a concept of "betrayal aversion" where people take risks less willingly when the agent of uncertainty is another person (trust) rather than nature (risk). People from some cultures lack trust and have more betrayal aversion, but less reliance on abstract damages as in US law (guilt) and more on vengeance (against shame).
It doesn't seem that this is useful in predicting panics or bottoms. But it seems clear that in a panic anybody who says "trust me" is asking for trouble. I think I know who I should trust, but I cannot quantify the risk, there is too much macro uncertainty. I'd like to be able to hedge my real estate risk but the hedge market is too small, not liquid, and terms too short.
In a bank run trust and risk go out the window along with the cash. Where do they go to?