Market frets over the next Bear Stearn

The sale of Bear Stearns to JP Morgan Chase has been described as the US\' Northern Rock but this underestimates its significance. The sheer size of Bear Stearns sets it apart.

Bear Stearns is an international investment bank with business lines including institutional equities, investment banking, global clearing services and asset management. It has approximately 14,000 employees worldwide.

In contrast, NR is a domestic specialised lender focussed on residential mortgages with some commercial lending and personal unsecured loan products. It has around 6,000 employees although recent reports suggest up to 2,500 of them face redundancy.

The Bear Stearns bailout has sent global stock markets tumbling, pushed gold prices to unprecedented levels and caused bond yields to plummet as investors seek shelter from the converging storms of the liquidity crisis, US recession and inflation.

In the UK, even overnight lending between banks has been squeezed, forcing the Bank of England to intervene with £5bn of additional cash in an effort to close the gap between LIBOR and the base rate.

The question in the minds of investors and banks is how many more Bear Stearns lie in wait? The scale of the discount at which the bank was sold suggests its balance sheet was significantly impaired. It was a big player in the US mortgage market and it is likely that the liquidity crisis hit it harder than most. But the suspicion that more Bear Stearns are to come is adversely affecting market sentiment.

As uncertainty continues, the pressure on central banks to act as lenders of last resort is growing.

But the effect of a liquidity crisis of this magnitude on such institutions is unknown and the consequences could be huge.

In essence, central banks are the mechanics responsible for keeping the financial system going. They’re usually engaged in fine tuning but are capable of more dramatic intervention. But the question is what happens if central banks don’t have the power to overcome risks in the market?

Markets move on daily stories. A Bear Stearns headline provokes short-term distortion as investors panic. In time, this panic subsides and conditions improve. It’s the job of central banks to quell panic as quickly as possible and ensure that structural damage is minimised.

The exposure of central banks to a sustained crisis is a systemic risk that bankers and governments will have to manage carefully. But in the short term, the question of which bank will be the next Bear Stearns will dominate market thinking.