8 weeks ago, the financial markets faced a great problem when news spread that Bear Stearns was running out of cash. On Thursday, March 13th, lenders refused to let Bear Stearns borrow any more cash to cover their assests. News spread like wildfire. Overnight, complete confidence in Bear Stearns ability to back investors evaporated. By Friday morning, investors were selling everything they had in Bear Stearns. In one day, the value of Bear Stearns dropped 47%.

The news caused a giant information cascade which sent the $8 billion dollar company into a deadly free-fall. Investors panicked, and every stock market was feeling the pain. Only two days after near record gains, the stock market was back to where it was, on the verge of a big recession. The information cascade was so severe that the Federal Reserve feared the worst, a recession the size of 1987. To stop the building crisis, the Federal Reserve lent J.P. Morgan the required cash to buy Bear Stearns and back all of its investments. The result, a much calmer market, and an eventual upswing in investor confidence.

The information cascade was the fear that such a large bank could go bankrupt overnight. Investors panicked and ignored their signals. Bear Stearns was not in as much trouble as investors believed, but they still ran to liquidate their assests in Bear Stearns. When this happened, the fear became a reality when Bear Stearns faced one of the biggist liquidity problems in decades. Only when the Federal Reserve stepped in did the problem calm down and investors began reading the signals. Since the buyout of Bear Stearns by J.P. Morgan, both the Dow Jones and NASDAQ are up. From March 17th to April 1st, the Dow Jones has seen a 2.7% increase, with the NASDAQ seeing a 9.3%. Once the cascade stopped, investors regained their confidence, used their own signals to make decisions, and everyone started trading again.

Sources:
http://www.washingtonpost.com/wp-dyn/content/article/2008/03/14/AR2008031401617.html
http://finance.aol.com/quotes/the-bear-stearns-companies-inc/bsc/nys
http://www.washingtonpost.com/wp-dyn/content/article/2008/03/11/AR2008031100893.html