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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

A risk analyst reviewing the collapse of Bear Stearns in March 2008 wants to identify the primary mechanism that forced the firm into a rescue sale. Which of the following best describes this mechanism?

Bear Stearns failed because of a confidence-driven liquidity run. Repo lenders and prime brokerage clients withdrew funding and cash balances rapidly, and the firm could not replace them. It relied on short-term secured funding rather than insured deposits, and its regulatory capital was reported above minimums.

  1. AA loss of confidence by secured funding providers and prime brokerage clients, which drained liquidity faster than the firm could raise cashCorrect
  2. BA regulatory decision to revoke the firm's broker-dealer license after an accounting fraud was uncovered
  3. CA sudden fall in retail deposits after a run on the firm's insured bank subsidiary
  4. DA failed equity offering that left the firm below the minimum regulatory capital ratio on its reporting date

Explanation

Bear Stearns was a dealer bank dependent on short-term secured funding (repo) and customer balances. When counterparties lost confidence, repo lenders pulled back and prime brokerage clients withdrew cash, creating a liquidity run even though reported capital ratios were above minimums. It had no large insured deposit base, so a retail deposit run is wrong.

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