Tuesday, March 18, 2008

The collapse of Bear Stearns

You might have heard about the sudden and spectacular collapse of Bear Stearns, one of the largest investment banks in Wall Street. But, what you probably did not know is that I have worked for Bear in 2001! Namely in Risk Management, of all departments! :-) Risk management is a relatively small but important department of an investment bank that very carefully studies the risks taken by all trading desks and incorporates them into a firm-wide risk analysis. It is staffed only by quantitative PhDs and very experienced ex-traders, and uses a lot statistical and financial modeling tools.
After a post-doc in Manchester and a visiting researcher grant at Trinity College, I started working at Bear Stearns in London at the central tower of Canary Wharf with a fantastic view of London. I was responsible for monitoring the equity derivatives desk in Tokyo. I worked on/next to the busy trading floor, and every week we had a video-conference to discuss the risk exposure for Bear. I have to say that I didn't get off to a good start: I had serious back problems (a prolapsed disk) and couldn't sit for longer than 20 minutes, house mates from hell, my stuttering was quite bad due to my back and high pace, and didn't get on well with my supervisor.
Bear is quite different to the other investment banks. They are more of a creative chaos led by talented traders rather than a well-structured bank with a systematic risk management approach supported by strong IT. We completely lacked IT integration of firm-wide data into a risk management system. There was always a concern for the credit derivatives that are very difficult to price, and this concern grew over the years as what I heard from former colleagues. My guess is that the reason for the collapse lies within senior management and their failure to limit exposure to difficult-to-priced securities, and the (political) weakness of risk management to make this case.
It is quite dramatic for the people who work there, as many received bonuses via company shares that are locked for 3-5 years and it was considered bad taste to sell them even after the lock-up period finished. By consequence, the Bear employees own 33% of their company and lost most of it. The top people were millionaires or billionaired, and their fortune dropped by 90%! However, I have no pity for them. It is insane to hold stocks at the same company that you are working. It's the most obvious mistake of diversification. Still, there is a perfectly reasonable argument for why they did this. Bear Stearns is the most aggressive investment bank on Earth dominated by trader mentality. Their ethos was: Show us loyalty to the firm by keeping your stock, and we are proud of you. They want to bind you, and make you part of themselves. They might have lost, but I wouldn't be surprised if they say to you: "So what? We played though and lost. I am proud of what I have done. Life goes on. I took the risk. Others run." For that, they deserve respect: they have all taken common responsibility for their actions or lack thereof, unlike CEOs who get outrageous bonuses without taking any risks and even get golden parachutes for messing up companies.


Adrian said...

Tom, is that you in the picture? ;-P

Tom Weidig said...

Yes, running away. :-)

Einar said...

Hehe, is that suitcase you're carrying full of 100-Dollar bill bundles ? Ok ok, I've been watching too many cheesy Wallstreet thriller movies...;O)

Dylan Bale said...

Do you think that BSC management deliberately misled investors, including employee investors, about the level of risk exposure and the prospects for the financial health of the company over the last 6-9 months?