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In August 2007 the Mainsail II SIV-Lite was frozen by its trustee as a result of the ongoing credit crisis. The state of Maine held $20 million of Mainsail commercial paper in its Cash Pool portfolio, a short-term portfolio that puts temporary, excess state revenues to work. When word of the potential loss became public, the Treasurer came under attack. The case introduces the functions of a state Treasury department, with particular emphasis on the investment objectives and guidelines for the cash pool as well as its composition. The case reviews the events leading up to and including August 2007, the month when the credit markets first began to seize and when the financial crisis effectively began. It examines securitization, structured finance, and the Mainsail SIV-Lite structure in some detail.

In January 2008, Citi and Merrill Lynch are trying to steer their ships back to calm waters. The new CEOs, Vikram Pandit (Citi) and John Thain (Merrill), have been at the helm of their companies for less than three months. This case focuses on their steps to counteract the massive losses resulting from their firms' investments in subprime-mortgage structures. What actions have these leaders taken thus far and what actions should they consider going forward? See also “Warren E. Buffett, 2008” (UVA-F-1550).

Hedge fund Magnetar Capital had returned 25 percent in 2007 with a strategy that posed significantly lower risk to investors than the S&P 500. Magnetar had made more than $1 billion in profit by noticing that the equity tranche of CDOs and CDO-derivative instruments were relatively mispriced. It took advantage of this anomaly by purchasing CDO equity and buying credit default swap (CDS) protection on tranches that were considered less risky. Now it was the job of Alec Litowitz, chairman and chief investment officer, to provide guidance to his team as they planned next year's strategy, evaluate and prioritize their ideas, and generate new ideas of his own. An ocean away, Ron Beller was contemplating some very different issues. Beller's firm, Peloton Partners LLP, had been one of the top-performing hedge funds in 2007, returning in excess of 80 percent. In late January 2008 Beller accepted two prestigious awards at a black-tie EuroHedge ceremony. A month later, his firm was bankrupt. Beller shorted the U.S. housing market before the subprime crisis hit, and was paid handsomely for his bet. After the crisis began, however, he believed that prices for highly rated mortgage securities were being unfairly punished, so he decided to go long AAA-rated securities backed by Alt-A mortgage loans (between prime and subprime), levered 9x. The trade moved against Peloton in a big way on February 14, 2008, causing $17 billion in losses and closure of the firm.

This case analyzes the strategies of the two hedge funds, focusing on how money can be made and lost during a financial crisis. The role of investment banks as lenders to hedge funds such as Peloton is explored, as well as characteristics of the CDO market and an array of both mortgage-related and credit protection-related instruments that were actively used (for better or worse) by hedge funds during the credit crisis of 2007 and 2008.

Gary Parr, deputy chairman of Lazard Freres & Co. and Kellogg class of 1980, could not believe his ears. “You can't mean that,” he said, reacting to the lowered bid given by Doug Braunstein, JP Morgan head of investment banking, for Parr's client, legendary investment bank Bear Stearns. Less than eighteen months after trading at an all-time high of $172.61 a share, Bear now had little choice but to accept Morgan's humiliating $2-per-share, Federal Reserve-sanctioned bailout offer. “I'll have to get back to you.” Hanging up the phone, Parr leaned back and gave an exhausted sigh. Rumors had swirled around Bear ever since two of its hedge funds imploded as a result of the subprime housing crisis, but time and again, the scrappy Bear appeared to have weathered the storm. Parr's efforts to find a capital infusion for the bank had resulted in lengthy discussions and marathon due diligence sessions, but one after another, potential investors had backed away, scared off in part by Bear's sizable mortgage holdings at a time when every bank on Wall Street was reducing its positions and taking massive write-downs in the asset class. In the past week, those rumors had reached a fever pitch, with financial analysts openly questioning Bear's ability to continue operations and its clients running for the exits. Now Sunday afternoon, it had already been a long weekend, and it would almost certainly be a long night, as the Fed-backed bailout of Bear would require onerous negotiations before Monday's market open. By morning, the eighty-five-year-old investment bank, which had survived the Great Depression, the savings and loan crisis, and the dot-com implosion, would cease to exist as an independent firm. Pausing briefly before calling CEO Alan Schwartz and the rest of Bear's board, Parr allowed himself a moment of reflection. How had it all happened?

An analysis of the fall of Bear Stearns facilitates an understanding of the difficulties affecting the entire investment banking industry: high leverage, overreliance on short-term financing, excessive risk taking on proprietary trading and asset management desks, and myopic senior management all contributed to the massive losses and loss of confidence. The impact on the global economy was of epic proportions.

In January 2008, in the midst of the subprime-mortgage crisis, Warren Buffett is looking for good investment opportunities for his almost $50 billion in cash. As usual, he has been patient and careful in identifying the right opportunities; however, the amount of cash in his company has grown considerably, and with so much cash sitting idle, returns could suffer. This case can be used to pursue several objectives: (1) to showcase Warren Buffett's leadership in the financial markets; (2) to understand his principles and the principles of value investing more broadly; (3) to understand Warren Buffett as both a thinker and a leader in the world of investing and as an agent of stability in a world of capital markets characterized by continuous change; (4) to discuss Buffett's investment decisions (Swiss Re, Burlington Northern, the funding of his own new bond-insurance business, BHAC) and the timing of those decisions in the midst of the subprime crisis and in an environment of increasing energy demand; (5) to discuss his decision not to invest in banks in the current environment as well as his largest investment, the philanthropic Gates Foundation; and (6) to understand some of the new market forces, such as sovereign funds, as providers of capital.

In early September 2008, in the midst of the subprime crisis, a manager with the student-run Darden Capital Management fund, wants to evaluate whether Comerica Incorporated, a regional bank based in Dallas, Texas, is a good candidate for inclusion in his portfolio. He needs to perform a valuation of the bank to assert whether the bank seems to be undervalued by the market or whether a further decline in value might be possible. He must account for all the factors that affect bank valuation, both as related to the bank itself as well as to the current market conditions. The case can be taught to: a) examine the valuation of a bank during turbulent times; b) understand the key accounting statements (balance sheet and income statement) for a bank and how they may differ from those for an industrial company; and c) understand the key value drivers of bank value (metrics for profitability, credit quality, liquidity, and capital).

In mid-January 2008, Merrill Lynch announced a $6.6 billion mandatory convertible-preferred share issuance, much of which was placed privately with the Kuwait Investment Authority (KIA), the Korean Investment Corporation (KIC), and the Mizuho Corporate Bank. The case is set during the subprime-mortgage crisis, which plagued banks and depleted their capital. It focuses on the decision of John Thain to issue capital and place it with sovereign wealth funds (SWFs) in an effort to stabilize the company and put it on the road to growth and profitability again. The case describes the various types and origins of SWFs, their orientation, and their recent intensive investment activity in the global financial-services sector. The case also discusses the transparency of SWFs and their role in the global financial system as liquidity-providing long-term players. Finally, Merrill Lynch's decision to issue the specific financial instrument to replenish its capital (mandatory convertible-preferred) and its terms are analyzed.

In recent years Lehman Brothers, one of the five largest investment banks in the United States, had grown increasingly reliant on its fixed income trading and underwriting division, which served as the primary engine for its strong profit growth. The bank had also significantly increased its leverage over the same timeframe, going from a debt-to-equity ratio of 23.7x in 2003 to 35.2x in 2007. As leverage increased, the ongoing erosion of the mortgage-backed industry began to impact Lehman significantly and its stock price plummeted. Unfortunately, public outcry over taxpayer assumption of $29 billion in potential Bear losses made repeating such a move politically untenable. The surreal scene of potential buyers traipsing into an investment bank's headquarters over the weekend to consider various merger or spin-out scenarios repeated itself once again. This time, the Fed refused to back the failing bank's liabilities, attempting instead to play last-minute suitors Bank of America, HSBC, Nomura Securities, and Barclay's off each other, jawboning them by arguing that failing to step up to save Lehman would cause devastating counterparty runs on their own capital positions. The Fed's desperate attempts to arrange its second rescue of a major U.S. investment bank in six months failed when it refused to backstop losses from Lehman's toxic mortgage holdings. Complicating matters was Lehman's reliance on short-term repo loans to finance its balance sheet. Unfortunately, such loans required constant renewal by counterparties, who had grown increasingly nervous that Lehman would lose the ability to make good on its trades. With this sentiment swirling around Wall Street, Lehman was forced to announce the largest Chapter 11 filing in U.S. history, listing assets of $639 billion and liabilities of $768 billion. The second domino had fallen. It would not be the last.

This case covers the period from the sale of Bear Stearns to JP Morgan to the conversion into bank holding companies by Goldman Sachs and Morgan Stanley, including the Lehman Brothers bankruptcy and the sale of Merrill Lynch to Bank of America. The case explains the new global paradigm for the investment banking industry, including increased regulation, fewer competitors, lower leverage, reduced proprietary trading, and-potentially-reduced profits.

This case invites students to evaluate, based on given materials, the causes, consequences, and potential resolutions of the financial crisis of 2007–2009. The premise of a business professor preparing a slide presentation dramatizes an analysis of the financial crisis. Reviewing his data, much of it in graph form, the professor ponders the central role of banks and the impact of risk management, leverage, and incentives. His main thesis is that the fundamental issue surrounding this crisis was the misjudgment of the risks taken, with the result that risk management failed to do its job of curtailing and managing risk as expected.

The case intends to achieve the following objectives with the audience: Apply the knowledge of fundamental analysis to select good companies for investment; analyse companies for investment through the contrarian strategy; and appreciate the need of own research before investing.

This case study provides an insight into the general process around investment for a retail investor. The protagonist of the case, Rajdeep Sharma, is a middle-class, salaried IT consultant from India. He has taken inspiration from Rakesh Jhunjhunwala, a renowned investor in India, and started his journey on the road to generate wealth. He decides to adopt the contrarian strategy and identifies Jaiprakash Associates Limited (JPA) to invest his savings. JPA is a large conglomerate with decades of experience, which has diversified business across multiple sectors. However, JPA’s pursuit of growth and expansion has created financial issues because of a large amount of debt it has amassed over the past few years. The company has been unable to repay its interest and principal obligations to the debt holders, making it consider a restructuring plan to meet these responsibilities. Meanwhile, Rajdeep has been optimistic about his investments but must experience excessive turmoil due to the high volatility in the company’s share prices. The case highlights the value of sound analysis, along with the impact of information on retail investors’ decision-making process. It will help prospective investors appreciate the importance of economic, sectoral and financial statement analysis before making any investments.

Fundamental analysis for MBA students majoring in Finance.

Teaching notes are available for educators only.

CSS 1: Accounting and Finance.