If you don't understand how an investment bank like Bear Stearns, which doesn't have depositors, can suffer a bank run, Felix Salmon does an excellent job of explaining:
They don't take retail deposits from individuals: there's no such thing as a Bear Stearns checking account, as far as I know. But that doesn't mean they can't suffer from a bank run. Except in this case it wasn't individuals withdrawing money, but hedge funds and other banks.Bear had a large balance sheet, full of highly-rated bonds. If it ever needed cash, it could go to the repo markets and essentially borrow money against its own balance sheet: it would sell the bonds to a counterparty, and promise to buy them back at a slightly higher price the following day or the following week.
But then, last week, the repo window slammed shut for Bear. Other banks would no longer accept Bear Stearns as a counterparty, which meant that Bear couldn't use its balance sheet to raise cash.
Then, to make matters worse, the hedge funds all started deserting Bear as well. Bear has a large prime brokerage operation: it looks after hedge funds' assets, basically, and will lend them money against those assets as needed. But the hedge funds, worried that Bear didn't have the money to lend, started moving their assets elsewhere, and Bear's highly profitable prime-brokerage franchise started spiralling downwards.
Without the trust of other banks or hedge funds, Bear was toast. And the famously sharp-elbowed Bear was never much loved on Wall Street to begin with. Maybe it's true that the rest of the Street was simply waiting for an opportunity to get back at Bear for real and imagined slights, including the refusal to play ball in 1998. But I don't think the Fed was bearing any grudges; its job was simply to mop up in the aftermath.
Ya know, iffin' peep didn't understand this previously, they had no business in the Financial Markets in the first place..
No matter that their 401(k) Plans are skewed 'long-only', or not..nor, if they had no idea that Puts, purchased, act as Insurance for, the same, long bias..
Can somebody explain how the repo market works?
Oh, and why and how did the repo window shut for Bear?
I'll give a shot at explaining the Repo market.
Repo is short for Repurchase Agreement.
The way it works is that if Bear needs cash to pay someone. They take an asset they had like a bond, and sell it to another bank. That bank agrees to sell the bond back to bear at an agreed upon price and Bear agrees to buy back at that price.
The diffrence in the price today and the price in a day or two represents the intrest paid on the short term loan.
The rate on these loans is typically very low close to LIBOR (london interback offer rate) because the loaner holds the bond as colateral.
It really is similar to a home equity loan in that you are leverage long term assets as collateral to create cash.
My guess on the Repo window shutting is that Bear wanted to use securities backed by mortgages to exchange in the Repo market. With the questions surrounding what could be in thos securities people would not take them as collateral.
Another potential is that people were worried that Bear would not be around to buy back even good securities so if the market moved and Bear was not around to buy the security back the counterparty would be stuck with a loss.
These are just guesses on my part. Someone else may know more details.
Re: My guess on the Repo window shutting is that Bear wanted to use securities backed by mortgages to exchange in the Repo market.
I would be surprised if Bear was pledging its securities because technically it doesn't own them, a dummy trust does. More likely it was seeking to use unsecuritized mortgages and commercial paper that it owns outright.