Bear Stearns was previously one of the largest and most significant securities trading firms in the United States. At its peak, it had an asset base of nearly $400 billion. The investment bank engaged in a broad range of financial activities, including the clearing and trading of derivatives and securities, investment banking, brokerage services, and the creation and packaging of residential mortgages and commercial property loans.
During the subprime mortgage crisis and the onset of the Global Financial Crisis, the company’s financial health rapidly and disastrously declined from mid-January to mid-March 2008. On March 13, Bear Stearns informed the Federal Reserve that it would not have enough liquid assets to meet its financial obligations the following day and that it could not secure alternative financing from the private sector in time.
The Federal Reserve believed that the imminent insolvency of Bear Stearns would cause chaos in the financial markets, as the firm was a key player in several critical markets, including foreign exchange, over-the-counter derivatives, repo transactions, securities clearing, and mortgage-backed securities.
The Fed feared that the failure of this systemically important investment bank would severely disrupt the daily operations of the nation’s and even the world’s financial markets, as Bear Stearns would be unable to meet its counterparty obligations. To address this, the Federal Reserve decided to provide credit to facilitate an orderly resolution of the firm’s affairs. With limited options available, the Federal Reserve Bank of New York extended a $12.9 billion credit to Bear Stearns through JP Morgan Chase Bank to address the firm’s urgent liquidity concerns and prevent systemic disruptions in the already stressed credit markets. The loan was secured by $13.8 billion in assets on Bear Stearns’ balance sheet.
The purpose of the bridge loan was to ensure that the investment bank could meet its same-day and next-day obligations to counterparties, giving it the weekend to explore options and discuss possibilities with other financial institutions to avoid bankruptcy. This also provided federal policymakers with time to devise ways to limit contagion to other financial institutions and markets if a private sector solution did not materialize.
On Monday, March 17, the entire $12.9 billion emergency loan, along with nearly $4 million in interest, was repaid to the Federal Reserve Bank of New York. Critics questioned how the Federal Reserve could take such an extraordinary measure to provide credit to a member bank on such a large scale. The Fed cited Section 13(3) of the Federal Reserve Act, which allows the Board to authorize Reserve Banks to provide credit to corporations, partnerships, or individuals in unusual and exigent circumstances.
Despite the Federal Reserve’s efforts to save Bear Stearns with the bridge loan, market pressure against the company increased over the weekend to the point where it could not avoid bankruptcy by Monday, March 17, without substantial liquidity injections from the Federal Reserve or an acquisition offer from a larger, more financially stable institution. Fortunately, JP Morgan Chase and Co. emerged as a practical bidder, and Bear Stearns agreed to merge with JPMC before markets reopened on Sunday, March 16, 2008.
As part of the merger and due to the uncertain scale of potential losses Bear Stearns faced from the stressed credit markets, the Fed assisted with the transaction. The FRBNY was directed to create a special entity, Maiden Lane LLC, to absorb Bear Stearns’ trading portfolio. This Fed holding company purchased and gradually wound down approximately $30 billion worth of Bear Stearns assets using a $29 billion loan from the FRBNY and a $1 billion loan from JPMC.
