Bear Stearns was formerly among the biggest important securities trading outfits within the United States. At one point it boasted a total asset base of almost $400 billion. The investment bank pursued a wide variety of financial activities. Among these were the clearing and trading of derivatives and securities, investment banking, brokerage account services, and creating and packaging up residential mortgages and commercial property loans.
In the swamping wake of the subprime mortgage meltdown and beginnings of the Global Financial Crisis, the company’s financial condition rapidly and catastrophically deteriorated from the middle of January through the middle of March in 2008. March 13th was the day when Bear Stearns informed the Federal Reserve it would no longer have sufficient liquid cash-like assets or funds in order to cover its financial responsibilities the next day. It reported that there was no practical way it could come up with an alternative means of financing in time from the private sector.
The Federal Reserve considered that a looming insolvency of Bear Stearns the next day would create havoc in financial markets. This investment bank and brokerage was a dominant figure in a few different critical financial markets. Among these were especially the foreign exchange markets, over the counter derivative transactions, repo transactions, securities clearing services, and the market of mortgage backed securities.
The Fed considered that contagion from the failure of this systemically critical investment banking and market-making firm was highly likely. They feared that the day to day operations of the nation’s (and even world’s) financial markets would be severely compromised at the point where Stearns could not cover its various counterparty obligations. The Federal Reserve opted to provide credit so that the firm’s affairs could be resolved in an orderly fashion.
The Federal Reserve considered the range of options and found they had grown thin. In order to deal with the urgent liquidity concerns Bear Stearns suffered from, they opted to have the FRBNY Federal Reserve Bank of New York extend $12.9 billion in credit via JP Morgan Chase Bank to Bears Stearns. This was necessary in order to delay systemic disruptions which the bankruptcy or at least default of the firm would have created in credit markets that were already highly stressed. The loan itself became secured by the $13.8 billion in market value assets which Stearns claimed on its balance sheet.
The entire reason of being for the bridge loan from the Federal Reserve Bank was to make certain the investment bank could cover its same-day and next-day obligations to counterparties. This would give it the weekend to consider what its options were and to discuss possibilities with the other major financial institutions that would make it possible to sidestep bankruptcy. It would also provide federal policy makers with some time to figure ways to limit the contagion to other financial institutions and markets if a private sector-based solution did not materialize in time.
On Monday, March 17th, the entire $12.9 billion emergency loan via JP Morgan Chase Bank to Stearns had been paid back to the Federal Reserve Bank of New York along with an almost $4 million in interest. Many critics at the time wondered how the Federal Reserve could pursue such an extraordinary measure as to provide credit to a member bank on such an enormous scale. The Fed cited Section 13(3) under the Federal Reserve Act. This allowed the Board itself to order Reserve Banks to provide credit to corporations, partnerships, or individuals in unusual and extraneous circumstances.
Despite the heroic efforts of the Federal Reserve to save Bear Stearns with its bridge loan, over the weekend the market pressure mounting against the company increased. It soon reached the point that it could not escape from bankruptcy by Monday, March 17th unless it received enormous liquidity injections from the Federal Reserve or an offer for acquisition by a larger, more financially sound financial institution. Fortunately for markets at that point, there was one such practical bidder in the form of JP Morgan Chase and Co. Bear Stearns agreed to merge with JPMC before markets reopened. This happened on Sunday, March 16th of 2008.
As part of the merger and because of the unknown scale of possible losses that Stearns faced from the stressed credit markets, the Fed had to help out with the transaction. The FRBNY was ordered to form a special Maiden Lane LLC to absorb the trading portfolio from Bear Stearns. It was this Fed holding company that purchased and gradually wound down around $30 billion worth of Bear Stearns assets utilizing a $29 billion loan from the FRBNY and a $1 billion loan from JPMC.