Have you heard of Bear Stearns? Their ticker symbol is BSC. BSC is was one of the most prominent investment banks on the globe until last week. On March 14th, 2008 Bear Stearns announced the need for emergency funding from the Federal Reserve Bank in order to maintain liquidity. To many that might sound like Spanish. What did they mean? Bear Stearns basically said, “we made some bad decisions and noticed we don’t have any money”. This is a result of bad investments, many revolving around the real estate bubble.

Ignore all the talk about why the company is in a mess for a second and this might sound familiar. Enron and Worldcom were screaming like Jacob Marley at Scrooge when I read about this. It is impossible for the following to happen so drastically unless someone in the company was hiding things:

Throughout 2008 Bear Stearns stock has suffered like all the other banks. Then the announcement came. BSC closed at $57.00 per share on Thursday, the 13th. JP Morgan made an offer to buy the company after the Bear Stearns announcement. Asking price? $2.00 per share. And they mostly just want their building in New York. If you owned $100,000 in Bear Stearns on the 13th, its now worth $3,500 (give or take a few bucks). That is how a stock can tank overnight.

My company 401k provides matching contributions in the form of company stock. What if I had been with BSC for 30 years and had $1,000,000 worth of company stock? If you’re thinking greeter at Wal-Mart, you’re on the right track. In a big corporate meeting last year, one of my bank’s executives proudly stated he was putting his entire 401k into company stock. I laughed out loud, thankfully I was listening in via phone from my desk though. Taking note of this, I marked the stock price on the day he said this. Assuming he really did this, and his 401k was worth $1,000,000, its now worth about $500,000. Not nearly Bear Stearns quality tanking, but my own 401k would be worth $908,000 comparatively. Just so you know, I do not yet get the company match (1 year of service). When I do, I will sell it and buy based on my portfolio balance. I’ll never have big overnight gains, but I’ll never have big losses. DIVERSIFY!!!! My job already exposes me to enough risk with one company. If that happened to me, I would be out of the job. Better not rely on my company stock to fund retirement too.

Now, what does the Bear Stearns case mean for you? Not much in the long term. My bank’s head analyst speculates this will be the defining moment for the credit crisis that defined the first decade of this millennium. He makes a valid point citing Bear Stearn’s may have started all this with a big write-off (that means acknowledging lost money) last year, due to sup-prime mortgages. Text book writers will be eager to study this when the dust clears. It’s a great case study on how not to conduct business.

Advanced finance classes would talk about how you can make money in this situation. You can skip this if you want. I promise I won’t use any formulas or crazy terms though. There is an investment out there called a Put. It is an option to sell something you own at a set price. I can buy the rights to sell a stock at a certain price. We’ll say I bought the rights to sell Bear Stearns stock for $35 per share (known as the strike price) on March 13th. for $2.00. That means I only spent 2 bucks for this contract. If the stock drops to $2 per share, and I have the rights to sell at $35, this contract/option is now worth quite a bit of dinero. Here’s a real life example. A real put option with a $35 strike price cost $8.60 on Friday, March 14th. That option is now trading at over $30 due to the demand to sell the stock at that price. Wrap your head around this:

If I had purchased $100,000 worth of these options on Friday, that’s 11,628 contracts, today it would be worth $362,793.60!! Not a bad overnight return for a stock that went DOWN, though you would have to be a psychic to see this coming. Modern investment strategies combine buying options with buying the stock to protect against stock going up or down. I have helped create software designed to crunch the numbers.

In the end, Bear Stearns has shown is exactly what can happen to a “stable” company. Investors and shareholders demand greater returns. At some point, someone will take on too much risk and then cover it up. In a large company, it can be too late by the time the problem is discovered. Oh, and diversify your portfolio. All together, Bear Stearns made my portfolio drop by .00002%.

Bonus: The shareholders and employees are suing themselves.

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