WHAT REALLY HAPPENED TO BEAR STEARNS?
All essays in this newsletter, including those by silver analyst Ted Butler, express the sole views of the authors. Investment Rarities does not necessarily endorse these opinions.
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Six years ago the well-known investment bank Bear Stearns imploded. In February 2008, Bear Stearns stock traded as high as $93; by mid-March the insolvent company agreed to be taken over by JPMorgan for $2 a share (later raised to $10 after class-action lawsuits). In the annals of Wall Street, there was hardly a more sudden demise than the fall of Bear Stearns. The cause was said to be a run on the bank as nervous investors pulled assets from the firm. Bear Stearns was said to be levered by 35 times, meaning it had equity of $11 billion and total assets of $395 million. This is a very small cushion if something negative suddenly appears.
Something negative did hit Bear Stearns in the first quarter of 2008; although there are remarkably few details of what went wrong. Since Bear had a significant presence in sub-prime mortgages and that market was in distress, it is assumed the fall of the firm was mortgage related. That may be true, but there was no general stress in the stock market through mid-March 2008 reflecting a credit crisis. Was there instead some other factor behind the company’s sudden collapse?
I believe that massive losses and margin calls of more than $2.5 billion on tens of thousands of short COMEX gold and silver contracts killed Bear Stearns. Bear Stearns was the largest short in COMEX gold and silver at the time. The day of Bear Stearns’ demise coincides precisely with the day of historic high prices in gold and silver. On this day the biggest COMEX gold and silver short experienced a maximum loss and a cumulative demand for upwards of $2.5 billion in cash deposits for margin. It was no coincidence the music stopped for Bear Stearns that same day.
Gold prices rose from under $800 in mid-December 2007 to $1,000 in mid-March 2008, a gain of more than $200. Silver prices rose from under $14 in mid-December to $21 when Bear Stearns failed. That was a gain of $7. Obviously, a $200 rise in the price of gold and a $7 rise in the price of silver is not good if you are the biggest gold and silver short.
The Commitments of Traders report (COT) data from the Commodity Futures Trading Commission (CFTC), in the relevant time period indicates the net short position of the 4 largest gold and silver shorts on the COMEX averaged 165,000 contracts and 60,000 contracts respectively. My analysis indicates Bear held 75,000 net gold contracts short and 35,000 net silver contracts short. A $200 adverse price move on 75,000 COMEX gold contracts would result in a mark to market loss and margin call of $1.5 billion. A $7 adverse price move on 35,000 COMEX silver contracts would result in a mark to market loss and margin call of $1.2 billion. Bear Stearns had to come up with $2.7 billion.
What happened to Bear Stearns was exactly what I had warned the Commodity Futures Trading Commission (CFTC) about continuously for the twenty years before the event. Aside from the manipulative impact that a concentrated market corner would have on price, the biggest risk was what would happen if the largest short ran into trouble. The facts in the case of Bear Stearns indicate that the worst did occur. The biggest short did go under.
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