After Bear Stearns, others could be at risk

NEW YORK - After Bear Stearns Cos. said Friday it will have to borrow money through JPMorgan Chase & Co., backed by the New York Federal Reserve, investors are curious: What does this mean for other banks, and who might be next?

Q: Is this going to happen to other investment banks?

A: Nobody knows for sure, but it could. Until proven otherwise, the market will probably act as if there are more near-collapses to come — just as it did on Friday, when investors sold off their bank holdings and sent the Dow Jones industrial average down 200 points.

"Even though Bear was probably on the fringe, pushing the envelope anyway, traders are saying that because it happened, it could happen to somebody else," said Brandon Thomas, chief investment officer for Portfolio Management Consultants, the investment arm of Envestnet.

Which other institutions might need funding?

Bear Stearns has been the weakling among the five reigning Wall Street investment banks: Bear, Merrill Lynch, Morgan Stanley, Lehman Brothers and Goldman Sachs. Many market watchers will recall that last spring, Bear was the first of these institutions to reveal big problems with mortgage-linked debt when it had to pump cash into two hemorrhaging hedge funds.

Also, Bear is the smallest of the five big investment banks, the least diversified, and the biggest issuer of mortgage-backed securities.

But Lehman Brothers Holdings Inc. appears to be an investment bank that investors are very worried about right now — mainly because it is the investment bank that is most similar to Bear in structure and exposure. Its stock dropped more than 14 percent on Friday.

Banks gave Lehman a vote of confidence of sorts, however, on Friday — Lehman Brothers said its new credit facility was "substantially oversubscribed," and that some of world's largest banks participated.

Other banks certainly have their own troubles — Merrill Lynch, for one, wrote down more than $14 billion in the fourth quarter as the value of bonds and debt backed by souring mortgages fell.

However, "there's not the same questioning of their franchise. It's not anyone saying, what are they going to do for a living next year," said Tanya Azarchs, S&P banking analyst. "At the same time, though ... the markets are very nervous, very skittish. Asset prices are very volatile. The repo markets are very tight, very illiquid. When the repo markets are illiquid, things can get very unpredictable."

The repo, or repurchase, markets are temporary loan markets that are relied upon by banks, hedge funds and other investors to invest their extra money or borrow against collateral.

What will happen to Bear Stearns?

Few industry experts believe the 28-day loan will be enough for Bear to become liquid on its own again — most are viewing it as delaying tactic as Bear and the Fed figure out how to proceed.

It is possible Bear will be bought, perhaps by JPMorgan. If that happens, the buyer would have to take over Bear Stearns' $176 billion worth of distressed securities and its $42 billion in loans — not a rosy prospect for even a healthy bank. Furthermore, there are regulatory issues that may arise if a commercial bank wants to buy Bear's troubled assets.

Another scenario is that the Fed attempts to organize an orderly winding down of Bear Stearns into a much smaller company by selling off its assets.

How is Bear's loan different than other steps troubled financial institutions have taken?

Bear Stearns is not the first company to seek out cash — Citigroup Inc., Merrill Lynch and Morgan Stanley have pulled in several billion dollars by selling stakes to outside investors, including foreign governments, while the bond insurer MBIA Inc. sold a significant stake in itself to JPMorgan, Lehman and other investors.

But Bear Stearns' agreement with JPMorgan is not a stake sale — it's financing planned and backed by the U.S. government.

Why can't the Fed just let Bear Stearns collapse?

Typically the Federal Reserve bails out struggling commercial banks, but because Bear Stearns is inextricably linked to a huge number of institutions, a failure could cause "a ripple effect," said Ali Samad-Khan, head of operational risk management consulting for the Enterprise Risk Management practice at Towers Perrin.

"They probably fall into the too-big-to-fail category," he said. "The fact is, they recognized that this is an important enough issue for them to get involved in."

Bear Stearns is interconnected with other banks, hedge funds and investors that are its "counterparties." Essentially, if Bear can't meet obligations to these counterparties, those counterparties will lose their money.

Big banks like Citigroup Inc. could see big losses but are probably large and diversified enough to survive them. But smaller players on the edges — particularly hedge funds — are at risk of going under if Bear can't repay them. A Carlyle Group fund has already said it is near collapse. Failing hedge funds could be another hit to major banks, who have lent huge amounts of money to the funds.

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