What's In Store for Bear on Monday?

On Friday, Alea's J.C. Kommer pointed us to an SEC press release about Bear Stearns:

According to the information supplied to the SEC by Bear Stearns as of Tuesday, March 11, the holding company had a substantial capital cushion. In addition, as of March 11, the firm had over $17 billion in cash and unencumbered liquid assets.

Beginning on that day, however, and increasingly throughout the week, lenders and customers of Bear Stearns began to remove funds from the firm, despite its stable capital position. As a result, Bear Stearns' excess liquidity rapidly eroded.

The title of JC's post was "Bear Raid".

That's not just a pun on the troubled firm's name. "Bear raid" is a term of art for a well-known, usually illegal, strategy. Suppose you know the positions of a heavily leveraged, capital-constrained player, and you'd like to have its assets on the cheap. Rather than trying to buy those assets, sell them short to drive down their prices. At the same time, start rumors that their current owner is insolvent. Soon the target starts getting margin calls it cannot meet, and is forced to liquidate its portfolio to satisfy creditors. This puts even more pressure on the already depressed prices of its holdings. Buy up the dying target's portfolio, along with the assets you sold short, for a song. Ka-ching!

Cassandra offered some wonderful musings on this kind of strategy in connection with the now quaint Amaranth meltdown.

It's unlikely that Bear's little liquidity problem last week was anybody's secret plot. There is quite enough spontaneous, organic panic in the market to explain how a teensy little rumor might spiral into a life-threatening crisis for a firm with an overstretched and uncertain balance sheet.

But, in light of the circumstances, I was troubled to read this CNBC story (via Calculated Risk):

The discussions indicate that potential bidders for Bear have been narrowed to [J.C. Flowers and JPMorgan Chase], although other last minute contenders could still weigh in... time has become a major issue for the investment bank... S&P lowered its long-term counterparty credit rating on Bear to "BBB" from "A," and it placed long-and short term ratings on credit watch with negative implications... Because of that S&P downgrade, bankers have now come to the conclusion that a deal must be done by Monday morning because no one on the street will trade or lend to Bear Stearns, which is rated a notch above junk bond levels... If there's no deal Bear Stearns will have to file for bankruptcy, executives said.

A quick sale, on its face, is an attractive option. It's a "market solution". Bear stockholders wouldn't be completely wiped out, and Bear's counterparties would be relieved to have a stronger player on the other side of their deals.

But a quick sale is likely to be a fire sale, and it's impossible for a transaction of this complexity to be adequately vetted in 72 hours. With all the world trying to get a deal done, whoever "buys" Bear might end up getting the firm's good assets cheaply without fully assuming Bear's potentially unknowable liabilities. (Recall the uncertainty still surrounding Bank of America's purchase of Countrywide.) In the very worst case, to make the crisis go away, the Fed might be asked to backstop some or all of Bear's obligations while a "buyer" cherrypicks the assets.

Viewed as a one-shot affair, this might seem like the best that can be done in a bad situation. But, alas, there are always those unanticipated consequences to consider. Bear Stearns probably was not the victim of an intentional bear raid. But, set the right precedent and the next bank to fall very well could be.

Bear Stearns has already been nationalized all but in name. Executives hinting that the firm will file for bankruptcy unless an immediate sale is arranged are playing a game of chicken with the Federal Reserve, trying to get paid now for stock that may be much worse than worthless when all the books are tallied. They suppose they have leverage, since the Fed has made clear that an abrupt bankruptcy would be too harmful to permit (probably because of Bear's role as a derivative counterparty, see Michael Shedlock).

Suppose that Monday morning, Ben Bernanke is presented with a deal, under which a buyer gets Bear assets on the cheap, Bear stockholders get paid out, and the Fed (implicitly or explicitly) bears residual risk. If the Fed doesn't approve, executives say, Bear will file for bankruptcy. Dr. Bernanke will then have an unappetizing choice. He can say yes, and hope that there aren't any more rumors out there about any other firms. Or he can say no, and make it very clear that if Bear Stearns files for bankruptcy despite the Fed's continuing provision of liquidity, he will do everything in his power to hold Bear executives personally responsible for the crisis that results.

A man who by all accounts is a very nice guy may be forced to play some very hard ball.

Comments

[AmesTiedeman]

It looks like JP Morgan Chase will come in and buy part of BSC. I have read that BSC in total is only worth $17.00. Barron's suggests more. It is just so very sad to see a great American institution stumble to badly. What are they teaching the boys at Harvard, Yale, and Stanford? That 30-1 leverage is noble?

[Dana Cole]

It appears that the "Banks" (read 'the people who run them') are so greedy that they are willing to put the entire banking system at risk rather than extend credit to each other. This pits Bernanke, who is the de facto banking representative of the American people, against selfish and unethical people who do not have the best interests of America at heart. Included amongst these, of course, are all the self-serving analysts and sensationalistic journalists, who - now that the War in Iraq has become old news and the elections are still a ways off - would rather make a name for themselves in the media by putting out fearful, attention-grabbing headlines than promote the financial well being of the country
When are we ever going to learn that what serves the best interests of all of us serves the best interests of each one?

[Briggsy]

This is the first step in nationalizing U.S. banks, which is a very good thing.

[buyitcheap]

This is incredible. Could we see a "bank holiday"?

[Dana Cole]

Just to add to my previous post:
Suppose the "self-serving analysts and sensationalistic journalists" I mentioned were all 100% right. Shouldn't we be thanking them for warning us of our precarious financial situation and putting out the alarm to sell all our stocks?
In a few, individual cases, perhaps yes. In the broader market sense, NO.
Here is why:
Capitalist economies are based on credit, and credit is based on trust. The current "credit crisis" is based on a loss of trust. Loss of trust comes from fear, and fear grabs attention. Those who use fear merely to get attention are thus undermining our economy. This is why the stocks of many companies that are financially sound are also down now.
I guarantee that the instant no one is interested in the "credit crisis" any more, it will cease to exist.

[User 164449]

Bought for $2 a share boys and girls.

[Dennis Lucey]

The buyout is for $2/shr.

www.jpmorgan.com/cm/Sa...

[DanielJacome]

BSC really went for just $1B, since the property on Madison is worth $1.2B according to sources.

Insane! Makes CFC look like they got a steal!

[User 149584]

What impact will the acquisition have on financials/the broader stock market in the immediate future?

[OutsideObserver]

Bad as the BSC debacle is... it is not a US version of the UK's Northern Rock story...YET. If a retail bank were to be next on the chopping block and FDIC insurance claims potentially taking months to resolve the next week/month everybody could be walking on a very high tightrope...

[GKM]

Wow, makes me want to run in and buy a bunch of financials tomorrow. If BSC is worth $2 (in paper not cash), what then are the other brokers or banks worth? What then are the values on the financial instruments held by the insurance companies? Not sure about anyone else but this doesn't exactly instill confidence in me.

[steveballmer]

Good news from MSFT will turn the entire market around!

[dieuwer]

FOREX not amused with this bailout, dollar crashes through 71.50, gold up $10+.

[DanielJacome]

" BSC really went for just $1B, since the property on Madison is worth $1.2B according to sources."

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sorry, I made an error - deal was for $236M, meaning BSC was valued at negative worth....

LEH will be in play Monday, ramping up on the balance sheet now, although if Joe Lewis couldn't make a decent bet here, how could us smaller investors ???

Clearly, Lewis, and this is an aside, doubled down and lost big - the beauty of Wall Street is that no one really has an advantage, smart people make gargantuan mistakes, and alas there is a reason equity holders sit at the bottom of the capital structure totem pole......

[User 151956]

since JPM already has 1 billion in debt with BSC, the deal is worth 1.25b or about 18 bucks / share. the crime here was that BSC was totally BK on thursday and the Fed gave JPM the entire deal on a silver platter versus vetting a sale. when its crunch time, all bets are off i guess.

[User 151956]

sorry, was referring to JPM's total cost to acquire the bank, not the value placed on the common shares. they were trading wallpaper on friday unbeknownst of course to most of the market. a lot of people bought from 20 to 30. too bad. i'd certainly call this a bottom.

[Timmay]

The Fed just cut 25 basis points, on a Sunday night!
timothysykes.com/2008/.../

[PJ568]

Although the purchase cost is 236M, 6B is the estimated cost of the liabilities being assumed by JPM.

[DanielJacome]

"i'd certainly call this a bottom."

----------------------

wait for WM or LEH to be taken under, then we'll celebrate.

[DanielJacome]

Cramer already has a piece out on Real money - looks good.

[DanielJacome]

Just heard Fuld of LEH flew rush trip back to NY given today's events' also hearing "stretch predictions" from desks that LEH will be sold, not buying the rumor yet, though.

Looking for LEH puts this week, XLF will hit another iceberg.

[Vukephalos]

Aside from the sale how did the Bridge game go?

[DanielJacome]

Dimon stole the company: again, he's a rockstar; expect at least 2 books on the Bear raid by Christmas

[HBS]

This guy's currently at Bear and may need to brush up his resume soon. Any suggestions or reviews would be great, looks like he's going to need it!

razume.com/resume/view...

[TimothySykes]

LOL, Cramer's piece is worthless, he's the equivalent of The Rock from the old WWF. This was his quote the other day:

“No! No! No! Bear Stearns is not in trouble. If anything, they’re more likely to be taken over. Don’t move your money from Bear.”

www.cnbc.com/id/235756...

Right about a takeover, off on the price LOL

[DanielJacome]

"“No! No! No! Bear Stearns is not in trouble. If anything, they’re more likely to be taken over. Don’t move your money from Bear.”"


people think takeouts are good, they forget about take UNDERs. Wall Street is about theft, one should EXPECT companies to be stolen just as easily as one's cash. Vice lubricates the entire investment mechanism - we wouldn't have it any other way

[DanielJacome]

Well, Timmy, he got half the trade right:

www.thestreet.com/p/_r...

[User 164505]

what will happen to my shares of bsc on Monday

[jeverett72]

pardon my french but Cramer is a f'ing idiot. his show should be taken off tv immediately. i wonder how much his viewer's have lost collectively on his bogus recommendations in the last 6-9 months.

[TimothySykes]

Hahah yes he did call the takeover, he was just about 99% off on the price. Somebody really needs to sue him just to get him to shut up

[mikeyjays]

do people really think LEH is in trouble.........If JPM stole BSC, would it not be a good idea to buy JPM...i hear it is down 2 bucks after hours..........