Can other firms avoid Bear Stearns' fate?

NEW YORK -- In the wake of Bear Stearns' shotgun marriage to JPMorgan Chase at $2 a share, investors might want to know how a financial institution with nearly $400 billion in assets and $12 billion in shareholder equity went from normalcy to near bankruptcy in just seven days.

While some experts blamed Bear's bsc fall on "opaque assets," "notional derivative exposure" and "liquidity demands," the answer is as old as the industry itself: a "run on the bank" is impossible to survive. "If the market is driven by an irrational fear, then it's very difficult to come up with a strategy that can quell that," says Kris Niswander of SNL Financial.

The key element in Bear's collapse is not the assets listed on its balance sheet, which totaled $395 billion at the end of 2007, but the portion of those assets that was in cash or cash equivalent: $34 billion.

When Bear's customers and clients started taking their cash out of the firm early this year, or demanding better terms on financing, Bear found itself in a classic fix: It needed to sell assets to raise more cash, but the assets it held on its books — many of which consisted of mortgage-backed securities — were difficult to sell.

According to Peter Schiff, president of Euro Pacific Capital, Bear found itself in a situation comparable to a beleaguered homeowner.

"You have a mortgage of $400,000, and one day you get a call from the bank and they say, 'We need all our money back.' If they say, 'Give me your money or we're taking your home,' you're in trouble," Schiff says. Bear found itself in just such a situation last week.

In January and February, a smattering of the 900 hedge funds that used Bear for prime brokerage services made inquiries at other firms, putting out feelers about whether they could shift their business there on short notice.

Early last week, a number of major hedge funds took their cash and business out of Bear and shifted to Bear's primary competitors in the area, Morgan Stanley ms and Goldman Sachs gs. The sudden departure of those hedge funds and word of their flight sparked a "run on the bank" for the firm, stripping it of much-needed cash.

It also spread fear among Bear's trading partners, making it prohibitively expensive for the firm to raise short-term cash.

The situation got so bad that by Thursday night Bear executives reached out to JPMorgan Chase jpm for help accessing additional funds. The Federal Reserve provided help, allowing the firm to access its discount cash window via JPMorgan, but the announcement of the bailout Friday only confirmed the rumors of a liquidity crisis that had been swirling around Bear all week.

Bear management had no choice over the weekend but to submit to any reasonable offer they could find, and JPMorgan Chase turned out to be the best suitor, in terms of business needs. As a result, Bear Stearns CEO Alan Schwarz — who had emphatically denied that the firm had any liquidity problems just last week — was forced into a deal late Sunday, agreeing to sell the 85-year-old firm to JPMorgan Chase for $236 million.

Tough times

With a lack of clear information about how widespread the problems are, investors are just selling. "Confidence continues to be in question for all the other firms out there," says Larry Adam, U.S. chief investment strategist at Deutsche Bank. db

Investors may get more information this week as several of the investment banks report earnings. Still, Adam doesn't expect the financial system to steady itself until housing prices stabilize, as real estate values are the basis of the problem. He's hoping the Fed's aggressive moves can limit the problems to Bear. "If you go back in history, these tend to be isolated cases," he says. But investors aren't taking much comfort in that, he adds. "This could continue to be isolated, but there is no way to say that with 100% certainty."

Bear's woes spread and inflicted damage on other brokerages and investment banks. Lehman Bros. leh fell $7.51, or 19%, to $31.75; Merrill Lynch mer $2.33, or 5.4%, to $41.18; and Citigroup c $1.16, or 5.9%, to $18.62.

Investors are "knocking the heads off everything having to do with financial services, even if they have nothing to do with mortgages," says Ken Winans, president of money management firm Winans International. What happed at Bear has "shaken people's confidence in what's usually a bastion of strength." While part of the selling smells of panic, there are some plausible worries that the problems that took down Bear could spread, Winans says. Those worries include:

•Ripple effect and length of recovery. More firms could also struggle. Winans "would be shocked" if Bear were the last. "When this begins to happen, it takes awhile for Wall Street to recover."

•Confusion about the industry. Not only are many of the troubled assets not clearly disclosed, there's concern that financial experts tracking the industry are in the dark.

Investors will shift toward companies people can understand, with good histories with credit and dividend payments. The pressure will not end anytime soon. "People are shifting away from financials, not just today, but for the rest of the year," Winans says. He thinks investors may be being overly hasty. "I question the thought of selling today at any price. What you'll look back in a month and regret," he says.

Krantz reported from Los Angeles