Delineate the reasons for the demise of Bear Stearns and evaluate the role of misaligned organizational architecture.© BrainMass Inc. brainmass.com March 5, 2021, 12:27 am ad1c9bdddf
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So let's look at Bear Stearns:
This was a hedge fund that catered to the very wealthy. Their strategy was aggressive and risky.
Part of the organizational architecture was that at BS, the fund managers took a chunk of the profits. This is not common among hedge funds. This meant that risky behavior was encouraged to maximize profits above all else, including stability.
Also, it entourages constant borrowing and leveraging to continually increase the amount of money the fund can invest - it encouraged poor behavior.
Management and incentive fees were huge. Again, this was part of the mismanaged organizational structure that eventually killed the fund.
Here's the method of BS's investment:
Debt obligations were bought. These were collateralized in that they had a physical object behind them (like a house). They got heavily into the subprime mortgage mess.
Money was then borrowed over and beyond the capitalization of the firm.
Profit was made because the subprime mortgages had a high interest rate. This was higher than borrowing money from a bank. Hence, the difference was the profit. As it turns out, the AAA rating (meaning it's the most stable and solid of all investments) of these subprimes was based on fraud. They were actually very poor investments that were radically overvalued.
Then, they engaged in what's called a "credit swap." This is a complex way to hedge bets in the case of default. If the mortgage holder defaults, the buyer of the swap is now responsible for paying BS the interest. In the meantime, the buyer is getting some of the interest payments.
I know this is complex - let me put the credit swap concept more simply: you buy your friend's health insurance policy from the insurance company. So long as he's healthy, he's paying his premiums to you. You're making good money. But as soon as he gets sick, YOU'RE stuck with the bill. See how it works? So long as the economy is growing and people are refinancing, the buyer of the ...
The reasons for the demise of Bear Stearns are examined. The role of misaligned organizational architecture is provided.