More questions than answers on Bear

I’ve just read through last night’s conference call on J.P. Morgan’s purchase of Bear (ht Calculated Risk). Overall, I’ve many more questions than answers.

  1. Sure, executives always talk up their deals. But really, this sounds like a fantastic coup for J.P. Morgan. They get Bear, which as a going concern was worth roughly $10B not long ago, for next to nothing. According to JPM execs, Bear was being candid when it insisted its books were fundamentally sound, and the crisis was just a liquidity issue. Much of the risk JPM might not have been comfortable with has been laid off on the Fed. jck at Alea notes that the markets, skittish about financials though they may be, have rewarded JPM with roughly $11B in excess market capitalization today. The market clearly views the deal as a windfall for J.P. Morgan. If a Fed-guaranteed Bear was a $10 billion bill just waiting for someone to pick up off the floor, why were there no so few bidders this weekend for the firm? Why was J.P. Morgan able to name its price? Alternatively, why didn’t the Fed itself purchase the firm for $2 a ticket and then negotiate at leisure a value-maximizing sale for the benefit of taxpayers?

  2. Why were Bear’s shares worth $30 Friday at 4 p.m. and close to $0 by Saturday evening? (Charlie Gasparino announced on Saturday that the firm would likely file for bankruptcy if a deal wasn’t done over the weekend.) Pointing to rating agency downgrades isn’t helpful. S&P and Moody’s have clearly tempered their pace of downgrading the monoline insurers and some AAA structured credits in order to mitigate systemic risk. I think it implausible that they would have downgraded Bear so quickly without some consultations. After all, as of Friday, Bear was perfectly liquid (thanks to the Fed’s special credit line), and it’s overall position looks to have been pretty solid. Somehow, something happened over a period of 24 hours that changed Bear from a slightly tarnished name that yet sell itself for a decent price to an urgently distressed asset. I’ve yet to hear a convincing account of how that went down. (Lawyers have already been called to look into this, and JPM has set aside funds for litigation.)

  3. The Fed is financing, and bearing the downside risk, on roughly $30B of Bear assets. About $20B of those are mortgage-backed securities, the rest are unaccounted for. Many of us — perhaps reasonably, perhaps hysterically — view Bear’s derivative portfolio rather than its mortgage-backed securities as the greatest concentration of risk. Is it possible (and I am asking here, I really don’t know!) that an “in-the-money” derivatives portfolio could be viewed as an asset, and pledged to the Fed? After all, synthetic credits include CDS positions, and we wouldn’t be surprised to learn that the Fed accepts highly-rated synthetic bonds as collateral. Very specifically, is the Fed’s downside risk on the $30B it has financed limited to $30B (the Fed gets stuck with worthless assets), or has it assumed a role as a guarantor of assets that could become outright liabilities under adverse conditions? I do not think this is likely, it would be too radical, too weird. But it would be nice to have explicit assurance that the portfolio whose losses the Fed has taken responsibility for includes only “limited liability” securities.

  4. In my previous post, I feared that Bear execs would use the threat of a destabilizing bankruptcy to try to extract an undue payout to shareholders. Now that the deal is done, and it is Bear shareholders who seem to be shafted, Andrew Clavell asks very pointedly why Bear did not use its bargaining power at least a bit more effectively. Why couldn’t Bear hold out for $4 per share instead of $2? Just how hard ball did J.P. Morgan and/or the Fed end up playing? Andrew points out that the option value of a share in bankrupt Bear might be more than the $2 consolation prize on offer. Why should Bear shareholders accept this deal (they must vote to approve it)? The possibility that Bear shareholders would not approve the deal was the risk Morgan executives seemed least capable of addressing during the conference call. They think shareholders will approve, but things will clearly get complicated if they don’t.

I want to reiterate, I think the outcome of all this is better than it could have been. I feel some sympathy for Bear stockholders, since fundamentally the firm may have been no less sound than its competitors. But managing liquidity risk was the Bear’s responsibility, and it failed to do so. From a “moral hazard” perspective, I’m glad an important player was allowed very publicly to fail. However, any salutary effect on incentives may be counterbalanced by the new funding facility for investment banks, which looks like a commitment by the Fed to bail-out any other firm in similar straits. I’m also a bit uncomfortable with J.P. Morgan’s windfall, which isn’t really a “market outcome”, and strikes me as a massive case of “private the gain, socialize the risk”.

I’m glad the Fed removed any incentive to try to bring down other firms via “bear raids”. But, as a correspondent of Yves Smith points out, investment banks may be safe, but hedge funds are suddenly vulnerable. I’d guess that the Fed is privately suggesting aggressive margin calls on hedge funds would be unwise right now. The Fed’s bully pulpit is in good shape, as a firm excluded from the Fed’s new liquidity facility would be one whisper campaign away from roadkill. The impaled carcass of a bear sits at the gate of Dr. Bernanke’s castle as a reminder to all of the price of being disliked.


8 Responses to “More questions than answers on Bear”

  1. March 17, 2008

    From: Earl L. Crockett

    In Praise of Bernard “Little Berney” Bernanke

    Being the reincarnated Jewish, or maybe Italian or Greek, grandmother that I am, I would like to rush over again to the Fed with another pot of chicken soup with matzo balls, linguini or chick peas, as the case may be, and make, sure that Little Berney is wearing the heavy wool sweater that I knitted for him for the last big religious holiday. And I do hope that Little Berney is at least getting a few hours sleep on that nice military cot, now set up in his office, that was sent over personally by that nice boy Dick Cheney, in place of his, Dickey Boy’s, assistant Dubya “B”, who was too busy making TV videos ad-nauseam last week about how he would like “the dollar to be stronger.”

    Enough of that, well…more than enough. The newspaper press doesn’t seem to get the amazing commitment that Bernanke has extended in just the last two weeks. The press is full of “$200 billion in funds” stories that seem to be like the partisan crowd at the Super Bowl cheering the last touchdown without them ever looking at the score board total from last summer. To date, Bernanke has laid out $360 billion between the “summer of 2007” and the end of the year 2007, $70 billion each in January and February for a total of $140 billion, started off with a bang in the first week of March 2008, with $100 billion in TAF funds, and another $100 billion for “related financial markets” (where do you think the $90 billion in support came from in the Bear-Stern’s bailout) with a commitment to extend these funding amounts for “another six months if needed” and then stepped right back in a week later on Tuesday March 11, 2008, and popped for another $200 billion for “bad” loan paper, forget about AAA Treasuries etc. So the “score board” since last summer now totals $900 billion with the above promise of “another six months if needed” leading to a potential of already committed and then “promised” funds through September 2008, of $2.1 Trillion.

    The above number crunching, has led me to “get”, and conclude, rather than “believe”, that Professor Bernard Bernanke PhD knows exactly what he’s doing down to the closest $100 billion. And why do I say that? Well… the estimated sum total of the US National Banking System equity is $2.2 trillion. If Bernanke goes beyond his already laid out, and promised amounts, it would be like your local bank “lending” more money to your neighbor,

    who has zero, or upside down, equity in his/her home, and your “neighbor probably has already told you that he/she is getting ready to “walk away”.

    To further my point about this being ultra-extraordinary times I will point to the Fed discount rate being dropped yesterday on a Sunday, a Sunday! It seems like the distinction, “business hours” has faded into history with about all of the other financial market “truths” that we once looked for, for comfort. Tighten your seat belts, boys and girls; it’s going to be one hell of a spring.

    Earl L. Crockett

    PS: My “financial market prayer” of the morning, “Will someone please tell me that I’m all, and totally, wrong about all of this”


    1.0 “Through the Looking Glass, and Down the Rabbit Hole”, March 8, 2008, ELC.

    2.0 “ Calling a Spade a Spade” March 10, 2008, ELC

    3.0 “Testing the Assumptions” March 13, 2008. ELC

    References available if requested by email:

  2. JB writes:

    I still feel the need to reserve for the possibility of malfeasance hiding inside of BSC’s book. I would accept Dimon’s contention that he had insufficient time to do proper due diligence particularly with respect to the derivatives book. As well as wanting a margin of safety for the risk of destroying JPM’s own capital on this adventure.

    I do think the Fed may be so concerned with seeking to select the course of action that produces the lowest overall costs to the “macroeconomy” (not sure if this is the correct term) that it is underpricing its services. Why couldn’t the Fed demand an equity kicker for effectivly providing, at least for a portion for BSC’s book, a layer of subordination? Or 1/2 interest in the skyscraper? The Fed is becoming a party to business transactions, and given the difficulty of having to act swiftly in a crisis, I might argue it needs its own set of advisors, its own “Lazard Freres.”

    Running with your idea, I think two problems with the Fed buying BSC for $2 and hiring JPM under an institutional services contract to operate Bear are: 1) the Fed becomes tangently involved in litigation brought by aggrieved shareholders and 2) the Fed would either have to guarantee past and future trades or pay JPM to do so, and what is the right price for that? Does the Fed have the expertise to operate a clearinghouse sans JPM?

  3. groucho writes:

    Steve, from your buddy felix:

    “So shareholders could vote against. If Bear Stearns then declared bankruptcy, the systemic consequences might be much smaller than if Bear declared bankruptcy today. The bank could possibly be liquidated in a relatively orderly fashion, and shareholders could end up with a lot more than $5 per share – eventually.

    What about rival offers? Well, they’re going to have to be unsolicited: the merger agreement basically says that Bear can’t shop itself around, but it can consider other offers if and when they arrive. I’m pretty sure that Jimmy Cayne, as chairman of the bank, can’t make a rival offer himself. But I’m unclear about the status of all the potential bidders who kicked the tires this weekend – did they sign something which precluded their making an unsolicited offer in the next few weeks?

    On the conference call, JP Morgan’s executives seemed pretty confident that the deal would go through at $2 a share, and that there wouldn’t be any other offers. The reasons for that confidence, though, were not easy to discern. Anybody have any insight?”

  4. anon writes:

    Re: ” The Fed is financing, and bearing the downside risk, on roughly $30B of Bear assets. About $20B of those are mortgage-backed securities, the rest are unaccounted for.”

    See the slide presentation, page 5:

    ” BSC leveraged lending funded and unfunded commitments of $8.9B; a portion of which could be pledged against the non-recourse facility ”

  5. Lorne writes:

    There was a shotgun aspect to the BS transaction: “Buy us out immediately or we’ll declare bankruptcy”.

    Then, thru Jim Rodgers, we learn that bonuses were paid to certain executives in the billion $ range in early March. The bankruptcy threat was a bluff: Bankrupcy of Bear within 30 days of the bonuses would require disgorgement the bonuses (according to bankruptcy law).

    Methinks there is something rotten in Denmark. Could it be a dumptruck load of BS?

  6. den writes: helping you get the home you deserve!

  7. GDAEman writes:

    Re: “… the price of being disliked”

    It’s worth reading Felix Salmon’s piece on “Market Movers.” He says it’s not the Fed that left Bear out in the cold, it was Wall Street.

    I see a real analogy playing out: The US as Bear and the rest of the World as Wall Street.

    It might be time for “we the people” to take back our economic system…. the Fed will have had a 100 year run come 2013. It’s time we reassert our control.

  8. groucho writes:

    In summary, we find massive volumes in the soon to expire March put options. It began in March on the 10th and continued through the day of March 14, 2008. The open interest in the options on the close of March 14 can be estimated by adding the open interest on March 17 to the volume that same day March 17. I would say that, given the massive volumes of March puts traded between March 10-14 (March contracts for a total of 200,000 to sell 20 million shares traded on March 14) followed by the crash of Bear Stearns on the 14 and 17 and large volumes in puts other than the March options, that this is the worse case of insider trading in the history of the world.

    Now comes the question of whether the SEC, the Exchanges and the Justice Dept will in fact prosecute those insider traders.

    Their profits should be seized immediately and forfeited.

    The beginning of the massive volumes on March 10, 2008 and continuing through March 14 also indicates that the bad news about the stock possibly going to two was being negotiated. This was contrary to statements being made by officials from Bear Stears.

    We will keep you posted.


    John Olagues