Can rumors bring about the demise of a venerated Wall Street investment bank? According to the Wall Street Journal, the Securities and Exchange Commission is currently looking into whether market rumors contributed to the downfall of Bear Stearns.

“Bear Stearns has been subject to a significant amount rumor and innuendo over the past week,” said Alan Schwartz, CEO of the firm. “Rumors intensified and given the nervousness in the market a lot of people it seemed wanted to act to protect themselves from the possibility of rumors being true and didn’t want to wait to see the facts.”

With the sub-prime mortgage crisis and talks of possible U.S. recession in the air, rumors regarding trouble at Bear Stearns began to spread in the market: the Fed was about to step in to help Bear manage a liquidity crisis. One by one, worried traders started to sell off stocks and everyone else started to do the same. Bear’s executives refuted rumors about the company’s liquidity squeeze, but it was too late. As the market began to lose confidence, panicked investors pulled funds and lenders cut off credit to the Wall Street bank. Price took a steep fall all the way from last year’s $170 per share to a mere $2 per share buyout offer from J.P. Morgan Chase, which totals up to $240 million. Apparently, JP Morgan Chase has decided that the Bear Stearns is only worth one sixth of the $1.5 billion Manhattan headquarter building, which is included in the buyout deal.

“One of Bears’ key mistakes may have been to ignore the rumors for too long. By the time the CEO appeared on TV, it was too little, too late,” writes Marketing Pilgrim’s Andy Beal. “When companies don’t come clean, it’s guilt by omission. In the absence of credible information, investors will fill that void with their own best guesses and follow the wisdom of crowds.” Information that each person infers from other shareholders’ choices overwhelmed the private information at hand.

Bear’s stock, however for some strange reason, never actually hit $2 per share bottom but jumped from $3 and hovered around $7 for awhile, leading more people into confusion. Herding behavior is also observed here because people, surrounded by uncertainty, are just watching how everyone else reacts. Everyone is thinking “something’s up.” Many investors came up with different theories and speculations on why the share is still hanging in there. Recently, J.P. Morgan raised the bid to $10 in order to calm angry Bear Stearns shareholders and close the deal.

Confidence seems to play a big role in how well the Wall Street banks perform. Once bad rumors of huge losses surface, the firm falls into trouble because everyone pulls their money away, making it worse and worse. Christopher Cox, the Securities and Exchange Commission Chairman, said the collapse of Bear Stearns was due to a lack of confidence, not a lack of capital. Cox noted that Bear Stearns’s problems escalated when rumors spread about its liquidity crisis which in turn eroded investor confidence in the firm.

Sources:

http://blogs.wsj.com/marketbeat/2008/03/20/hints-and-allegations-and-bear-stearns/

http://www.marketingpilgrim.com/2008/03/bear-stearns-a-lesson-in-rumor-monitoring.html

http://www.businessweek.com/bwdaily/dnflash/content/mar2008/db20080318_327039.htm?chan=rss_topStories_ssi_5

http://www.foxbusiness.com/markets/industries/finance/article/secs-cox-says-bear-collapse-crisis-confidence_529965_9.html

http://blogs.wsj.com/marketbeat/2008/03/14/the-bear-stearns-conference-call/