Was Bear Stearns Hurt by Fear, or Greed?

Last Updated Mar 19, 2008 1:39 AM EDT

It's often said that business behavior is either motived by fear or greed. For Bear Stearns - the Wall Street bank facing rumors of a liquidity crisis that proved self-fulfilling - the prime culprit forcing it into a government bailout seems to be fear. But I wonder.

Bear Stearns' rivals smell blood in the water, and according to the cold logic of the financial markets they'd be foolish not to profit from their peer's vulnerability. And they have some very effective tools to do so, starting with those rumors.

The Wall Street Journal noted "the lack of any proof that Bear actually faces a liquidity crisis." True enough. But it went on to show a way that competitors are profiting in the name of caution:

"Still, some of Bear's counterparties are becoming increasingly cautious. At Deutsche Bank, some traders of credit-default swaps and other derivative securities are charging extra when Bear is the counterparty, according to people familiar with the situation.

Increasingly, these traders also are charging hedge-fund clients a fee for novations, or situations in which the fund asks Deutsche Bank to take its position as a counterparty to Bear on a particular transaction.... A spokeswoman for Deutsche Bank declined to comment."

Those fees serve Deutsche Bank two ways: They offer it an instant premium for a deal that may be perfectly safe, and they send a message to hedge funds that it's a much stronger bank than Bear. Not bad for a day's work. Goldman Sachs went further, refusing to act as a counterparty to Bear trades.

In a video, Jim Cramer explained how easy it is for hedge funds to pull their money from Bear Stearns in a matter of hours.

"There's no difference in having your money in custody in Goldman, or in custody at Merrill, or at J.P. Morgan or at Bear. These are all commodities, so why have your money at Bear.... It was just as easy to have your money at Goldman as at Bear."
Now imagine how easy it is for a trader to phone up investors in hedge funds and point all this out. Presto. Instant liquidity crisis.

Bear is too big to be allowed to fail. But it's more and more likely that it will be bought out at bargain-basement price by one of its bigger competitors. That prospect gives those big banks one more incentive to see Bear Stearns go through all this pain.

Update: The SEC is reportedly investigating the motivations of those rumor-mongers.

  • Kevin Kelleher

    Kevin Kelleher writes a regular stock column at TheStreet.com and is a contributor to Wired, Popular Science, and GigaOm. He has previously worked as a reporter and editor at Bloomberg News, Wired News, and The Industry Standard.