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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Bear Stearns nearly failed in March 2008 and was acquired by JPMorgan Chase with Federal Reserve support. Which factor was most directly responsible for the speed of its collapse?

Bear Stearns collapsed quickly because it depended on short-term secured funding, mainly overnight repo, and on client balances. When confidence in its collateral and solvency fell, counterparties refused to roll over funding and clients withdrew, causing a rapid liquidity run rather than a deposit run.

  1. AA sudden rise in its regulatory capital ratio that restricted trading
  2. BHeavy reliance on short-term secured funding such as repo, which counterparties stopped rolling over once confidence in its collateral and solvency fellCorrect
  3. CA large retail deposit run following a government guarantee withdrawal
  4. DMandatory liquidation of its insured depository subsidiary by the FDIC

Explanation

Bear Stearns was an investment bank funded largely by overnight repo and prime brokerage balances rather than insured deposits. When counterparties lost confidence, they refused to roll funding and hedge fund clients withdrew balances, causing a liquidity run within days. It did not have a deposit base subject to an FDIC liquidation.

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