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Fear drives markets as investors speculate

It will be difficult for the economy to grow or for the market to reverse its course while fear is stalking the financial world.

Fear is why Bear Stearns Cos. was hit with what amounted to a run on the bank and is being sold for $2 a share, a 97 percent discount to where its shares were trading a week ago.

Fear is why the Federal Reserve is pulling out all the stops to manage the market turmoil, hoping to prevent conditions from turning so ugly that investors everywhere run for the doors.

Fear is why this credit crisis won't be resolved any time soon, because there are too many unknowns still lurking around the financial system that make it hard for anyone to feel confident.

The financial problems are not new. The troubles were set off last year by the alarming rate of defaults on subprime mortgages, which then caused an aversion to risk among lenders.

What's different now is how the turmoil has intensified in the last week. We are seeing a huge retrenchment of funds from all corners of the financial world.

That's particularly problematic for Wall Street firms, which have a client base consisting of individuals, companies, hedge funds and pension funds. They also lend and borrow billions of dollars daily with their financial-company peers. Should questions of liquidity arise at any of those players, it can roil the financial system.

"Wall Street CFOs have known for over 20 years that the loss of confidence is a life-threatening risk for a securities firm," said Brad Hintz, senior analyst at Sanford Bernstein. "Liquidity risk has been and remains the Achilles heel of the securities firms."

For Bear Stearns, problems have been building since last summer when the company revealed that some of its hedge funds had made bad bets on securities backed by risky subprime loans. The nation's fifth-largest investment bank has looked troubled, but never seemed to be in dire shape, even after reporting more than $2-billion in write-downs on mortgage assets last year and seeing its CEO James "Jimmy" Cayne step down in January.

Things changed over the last week, when rumors started that the investment bank was short on liquidity and might not have enough cash to do business. The company's executives tried to temper the market chatter. "Bear Stearns' balance sheet, liquidity and capital remain strong," said a March 10 news release. "There is absolutely no truth to the rumors of liquidity problems that circulated today in the market."

CEO Alan Schwartz two days later appeared on CNBC to reassure investors that the company had ample liquidity and he was "comfortable" it would turn a profit in its fiscal first quarter. By Thursday, the firms' solvency was being called into question, fueled by nothing but market speculation. Fear, not news, may have driven Bear Stearns to collapse.

The nation's central bank is trying to restore confidence in panicked financial markets by becoming a lender of last resort for Wall Street investment houses. But investors are already speculating "who is next" to fall, said Marc Chandler, global head of currency strategy at the investment firm Brown Brothers Harriman.

As we've seen in the case of Bear Stearns, that alone can bring a bank down.

Fear drives markets as investors speculate 03/18/08 [Last modified: Thursday, October 28, 2010 9:42am]
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