About · Press · Contact · Write For Us · Top Personal Finance Blogs
Featured In:

What We Can Learn From the Bear Stearns Down Fall

By Erik Folgate

If you keep up with current events and/or financial news, then you probably heard about the demise of Bear Stearns, a once large investment brokerage firm. Many were shocked when the news came out that JP Morgan would be buying Bear Stearns at $2 a share, when months ago the stock was trading at $85 dollars a share. Then, JP Morgan realized that others were trying to compete to buy Bear and offering a higher price, so JP Morgan increased the buy-out to $10 a share. So, let’s take a look at why Bear Stearns crumbled overnight.

Their debt to equity ratio was 32!

Debt to equity ratio is basically the liabilities of the company divided by the equity that the firm holds. Anything over 2 is supposed to be considered a high for a d/e ratio, and Stearns was at 32! The problem with all of these large investment firms is that they are a bunch of eggheads that went to famous business schools that taught them to leverage the hell out of their assets. You can argue that every company leverages their debt, but many don’t have a D/E ratio more than 2 or 3.

What this means to you: I am a strong proponent of not encouraging people to leverage their debt or assets. Many people are doing this with credit cards. They are maxing out the 0% credit card and placing the money in an online savings account to earn 3 to 4% interest. The problem is that by the time you consider taxes and the return that risk eats up, it’s not worth playing games with debt. A home equity line of credit is another way of leveraging one of your biggest assets, your home. When you take out a HELOC, that lender is going to become a second lienholder on your home. Don’t add more risk to the roof over your head. You can disagree with me on this one, but just look at Stearns. They took a financial principle taught every day and exploited it. Look where it got them? You may be able to get away with leveraging debt if you are conservative with it, but the problem is that greed rears itself into the equation and before you know it, you’re in over your head.

Bear Stearns invested in an unproven market

Bear Stearns had a lot of cash invested into the subprime mortgage industry. It’s funny because I am sure there were executives and senior analysts in the company that remember the LAST time the subprime mortgage industry crumbled. Subprimes have a place in society. They help people with less than perfect credit become homeowners, but the problem is that it gets exploited by greedy lenders and consumers with eyes bigger than their stomachs get sucked in. But, the fact that Stearns put so much of their assets into hedge funds that invested in the subprime market makes you wonder where the Stearn’s executives were educated. Again, it may have been just a case of greed.

How do you learn from this? Diversification of your investments is the single most important concept when becoming a serious investor. Investing heavily into one company, one industry, or having only one investment strategy is foolish. You are banking on the fact that the one company or industry will always do well, and it will never perform good at all times. You must make your investment portfolio diverse. I always make sure that my investments have an element of international stocks, so when the U.S. market is slow, it still has the chance for Asia and Europe to keep the portfolio strong.

I am guessing that this won’t be the only brokerage firm to go under, because many of them are still employing the same strategies as Bear Stearns. Hopefully, they will learn from the mistakes of Bear Stearns.

Erik Folgate
Erik and his wife, Lindzee, live in Orlando, Florida with a baby boy on the way. Erik works as an account manager for a marketing company, and considers counseling friends, family and the readers of Money Crashers his personal ministry to others. Erik became passionate about personal finance and helping others make wise financial decisions after racking up over $20k in credit card and student loan debt within the first two years of college.

Related Articles

  • ekrabs

    Excellent article. Well-said.

    The financial sector has been hit hard, by proxy of Bear’s collapse. Enough so that I think now is perhaps the perfect time invest in financials, as many of them are undervalued.

    I myself would have already done so, but my personal finances currently don’t have the room for me to do so just yet.

    Perhaps there’s another parallel in there to draw?

The content on MoneyCrashers.com is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, consult a licensed financial or tax advisor. References to products, offers, and rates from third party sites often change. While we do our best to keep these updated, numbers stated on this site may differ from actual numbers. We may have financial relationships with some of the companies mentioned on this website. Among other things, we may receive free products, services, and/or monetary compensation in exchange for featured placement of sponsored products or services. We strive to write accurate and genuine reviews and articles, and all views and opinions expressed are solely those of the authors.

Advertiser Disclosure: The credit card offers that appear on this site are from credit card companies from which MoneyCrashers.com receives compensation. This compensation may impact how and where products appear on this site, including, for example, the order in which they appear on category pages. MoneyCrashers.com does not include all credit card companies or all available credit card offers, although best efforts are made to include a comprehensive list of offers regardless of compensation. Advertiser partners include American Express, U.S. Bank, and Barclaycard, among others.
Close