JP Morgan and Bear Stearns

Topics: Corporate finance, Bank, Bear Stearns Pages: 5 (1497 words) Published: May 6, 2014
Background
In the last three decades, the US banking system has changed its investment procedures and its risk management due to changes in government regulation. Furthermore, external shocks, such as the inflationary period during the 70s and the recession in the 80s, led Banking institutions to alternative ways of investment in order to remain profitable. The average annual inflation rate from 1900 to 1970 was approximately 2.5%. From 1970, however, the average rate hit about 6%, topping out at 13.3% by 1979. This period is also known for "stagflation", a phenomenon in which inflation and unemployment steadily increased. A loose monetary policy led to very low interest rates. Corporations were borrowing large amounts to finance leverage buyouts (LBOs), which led to higher and high interest burden. One of the main instruments used was financial derivatives, which gave Banks additional profit. Moreover, this instruments represented off balance sheet activities, thus helping bank capital. Nonetheless, these instruments were risky and could led to enormous losses. In the late 70’s and early 80’s saw the rise of a number of financial products such as derivatives, high yield an structured products, which provided lucrative returns for investment banks. Also in the late 1970s, the facilitation of corporate mergers was being hailed as the last gold mine by investment bankers who assumed that Glass-Steagall would someday collapse. At this time we could see the first efforts to loosen Glass-Steagall restrictions and some brokerage firms begin encroaching on banking territory by offering money-market accounts that pay interest, allow check-writing, and offer credit or debit cards. Moreover, in 1974 NOW (Negotiable Order of Withdrawal) accounts were created by a small bank in Massachusetts, offering negotiable orders of withdrawal to permit payments on near-checking accounts at banks. In 1980, they were permitted for all institutions, with rate ceilings eliminated in 1986.

Bear Sterns and crisis
As an investment bank, Bear Stearns & Co. had three main operating businesses. The first one was Capital Markets, which included brokerage services, market-making and proprietary trading in both equities and fixed income. Moreover, this Capital Markets business also included investment banking services such as securities issuance and advice on mergers and acquisitions. Its fixed income business represented the highest contribution to its revenue. The second operating business was Global Clearing Services which included the company’s well-regarded prime brokerage business. Bear Stearns provided trade execution and securities clearing, custody, lending and financing to hedge funds and broker-dealers as a prime broker. The third operating business was Wealth Management which included Bear’s Private Client Services group, which served high-net worth individuals, and Bear Stearns Asset Management, which managed hedge funds and other investment vehicles. Bear Stearns & Co. was an investment bank, a financial intermediary that performed a variety of services. As an investment bank it specialized in large and complex financial transactions. Its primary regulator was the Securities and Exchange Commission and did not have access to the Federal Reserve discount window, which allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions unlike commercial banks. The main difference between a commercial bank and an investment bank such as Bear Stearns was that while commercial banking involved both taking deposits and making loans that remained on the lender’s balance sheet, investment banking involved the underwriting of debt and equity securities, buying them from the issuer typically with a syndicate of other firms and then selling them on to investors.

Many years ago it was difficult to say whether a bank engaged in...
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