Diary of a Crisis II: Bear, Lehman and into the Abyss

CHICAGO, September 10, 2009 — "As we approach the one-year anniversary of Lehman's demise, it is useful to take a look back and remember how fragile financial markets and the economy were prior to the company's failure: one of Wall Street's oldest and most venerable investment banks, Bear Stearns, was wiped out of existence; a run on IndyMac resulted in the second largest bank failure to date; and, the very backbone of the mortgage industry – Fannie Mae and Freddie Mac – were taken into conservatorship by the U.S. Treasury on account of their liquidity problems. Add to that a bankruptcy the magnitude of Lehman, and it is a bit of a shock that we didn't slip into another Great Depression," says Diane Swonk, chief economist of Mesirow Financial, in her September edition of Themes on the Economy.

Swonk's September newsletter is a sequel to the August issue of Themes on the Economy, both of which are part of an extensive research project that she is currently carrying out.

"We may have been able to avoid the massacre that occurred in the fall of 2008. For all the missteps, however, it seems painfully clear that we would have suffered an even worse fate if policy makers hadn't acted when they did:

"Rumors that mortgage losses were amassing at Bear Stearns began to surface in February 2008. By early March, large hedge funds were making enormous bets in the credit default swaps (CDS) market against Bear. The companys stock price, which traded at $100 per share in late 2007, had slipped below $70 per share."

March 11, 2008: Fearing that the run on Bear and primary dealers was getting out of hand, the Fed launched a new lending facility.

March 12, 2008: Alan Schwartz, the CEO of Bear Stearns, made a plea on CNBC from his vacation home in Florida: "We're not... aware of anybody who is not taking our credit as a counterparty. We don't see any pressure on our liquidity, let alone a liquidity crisis."

"Many on Wall Street appeared to be rooting for Bear's demise. Bear was the only major investment house that refused to help Long Term Capital Management (LTCM) at the height of the 1998 financial crisis and, as a result, had gained a reputation as a bully," says Swonk.

March 14, 2008: Bear announced that it was courting its rival, JP Morgan Chase, and the federal government for an emergency bailout.

March 16, 2008: At approximately 7:00 p.m. CST (8:00 p.m. EST), the Fed announced that JP Morgan Chase had agreed to purchase Bear Stearns for the jaw-dropping price of $2 per share, contingent upon a transfer of about $30 billion in illiquid or "toxic" mortgage assets from Bear's balance sheet to that of the Fed.

March 17, 2008: The $2 per share strike price came under immediate fire. This, coupled with a side deal that Jamie [Jamie Dimon, chairman and CEO of JP Morgan Chase] did to buy a controlling stake of the company from Bears board at $10 per share, forced Jamie to later renegotiate the offer to $10 per share.

March 18, 2008: The Federal Open Market Committee (FOMC) voted to lower the fed funds rate 75 basis points from 3% to 2.25% in an effort to shore up markets in the wake of the Bear Stearns "sale."

April 30, 2008: The FOMC voted to lower the fed funds target another 25 basis points to 2%. Fisher [Richard Fisher of the Dallas Fed] and Plosser [Charlie Plosser of the Philadelphia Fed] dissented.

"Things looked a little better once the $150 billion in stimulus checks started to hit consumer wallets. Nothing was left once we got to the third quarter. Home values plunged, putting an end to home equity borrowing and mortgage refinancing," notes Swonk.

July 8, 2008: Share prices at Fannie and Freddie plummeted more than 15% over concerns about loan defaults.

July 10, 2008: Fannie's and Freddie's share prices plunged further after Bloomberg reported that Bill Poole, former president of the St. Louis Fed, said that Fannie and Freddie were already insolvent.

July 11, 2008: At 3 p.m. PST (6 p.m. EST), the Office of Thrift Supervision (OTS) closed the Pasadena headquarters of IndyMac...

September 8, 2008: The Treasury put Fannie Mae and Freddie Mac into conservatorship.

September 10, 2008: Lehman announced a loss of $3.9 billion (after losing almost $3 billion in the second quarter)...

September 11, 2008: Rumors that Lehman was now looking for a suitor intensified, and the stock price fell another 40%. The top two contenders were Barclays and Bank of America (B of A).

September 16, 2008: Barclays purchased much of Lehman's investment banking unit out of bankruptcy...AIG's stock price plummeted 32% by mid-day (it had already taken a 61% plunge the previous day) and was downgraded by three ratings agencies.losses were mounting too quickly for anyone but the government to step in.

"The panic that had taken hold of financial markets intensified. Investors fled from investments that were associated with risk for the relative "safety" of the U.S. Treasury market, and the yield on treasury bills plummeted," says Swonk.

September 20, 2008: Treasury released a three-and-a-half-page draft, which would give the treasury secretary unprecedented authority...

September 21, 2008: Washington Mutual (WaMu) was merged into JP Morgan Chase, setting off a chain reaction of events, and further undermining the ability of banks to raise capital. The crisis was in full swing, and the worst was yet to come.

"Once Lehman fell there was nowhere for the economy to go but down," says Swonk. The question was how far were we willing to fall and how many lives were we willing to sacrifice before we did something about it?"

The September issue of Themes on the Economy as well as archived issues can be found at www.mesirowfinancial.com.

Mesirow Financial is a diversified financial services firm headquartered in Chicago. Founded in 1937, it is an independent, employee-owned firm with more than $30 billion in assets under management and 1,200 employees in locations across the country and in London. With expertise in Investment Management, Investment Services, Insurance Services, Investment Banking, Consulting and Real Estate, Mesirow Financial strives to meet the financial needs of institutions, public sector entities, corporations and individuals. For more information about Mesirow Financial, visit its Web site at www.mesirowfinancial.com.

The Mesirow Financial name and logo are registered service marks of Mesirow Financial Holdings, Inc., © 2009, Mesirow Financial Holdings, Inc. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. Any opinions expressed are subject to change without notice. It should not be assumed that any recommendations incorporated herein will be profitable or will equal past performance. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy an interest in any Mesirow Financial investment vehicle(s).

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