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

In Duffie's analysis of the failure mechanics of dealer banks, which feature of Bear Stearns' funding in March 2008 most directly explains why its liquidity collapsed within days rather than gradually?

Bear Stearns relied on short-term secured funding, mainly repo, plus prime brokerage client cash balances. When confidence dropped, lenders declined to roll over and clients moved balances away, so liquidity drained within days. It had no insured retail deposit base to stabilize funding.

  1. AHeavy reliance on short-term secured funding such as repo and on prime brokerage free credit balances, which clients and lenders withdrew quicklyCorrect
  2. BA large base of insured retail deposits that depositors withdrew en masse
  3. CLong-dated unsecured bonds that all matured in the same week
  4. DDependence on central bank discount window borrowing that was suddenly withdrawn

Explanation

Bear Stearns financed illiquid and complex assets with short-term secured funding and relied on clients' cash balances. When confidence fell, repo lenders refused to roll and prime brokerage clients moved balances, draining liquidity in days. It had no insured retail deposit base, and its bonds were not concentrated in one maturity week.

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