Bear's Bankruptcy Alternative

Would a bankruptcy have been better for Bear than a $2/share sale? We don't know. But I think a comment made by Alan Blinder, the noted Princeton economist, on the News Hour with Jim Lehrer this evening is telling precisely because it was wrong.

Blinder noted that the sale was basically the same result as a bankruptcy because equity was largely wiped out. That's true, but misses a very important point about bankruptcy: process matters.

There is tremendous process value to bankruptcy. There are safeguards to ensure fairness, claims are scrutinized, liens inspected, and assets are valued. To be sure, the process has large costs, but the process value is often missed in results-oriented analyses of bankruptcy that propose replacing the current system with less costly systems.

There is no guarantee that Bear's shareholders would have gotten $2/share in bankruptcy. They might have gotten less...and they might have gotten more. At the very least, though, they would have had a seat at the table, and given that about a third of Bear is employee-owned, the shareholders might have had a significant role.

We might also wonder what was drove the Bear's board decision. Did the board act solely on a cold, calculated comparison of sale and chapter 11 valuations? They knew the sale price being offered; I doubt they had a very good sense of whether a reorganization was possible in bankruptcy and how shareholders would fare. Lousy isn't really a good answer, as the issue is whether it would be more or less than $2. Is it possible that the stigma of bankruptcy played a role? Perhaps the board members preferred to sell the company than be known as the people who lead Bear to bankruptcy. Presiding over the collapse of a major investment bank is bad. Presiding over its bankruptcy might be worse.

One final thought on a Bear bankruptcy: would a trustee or examiner have been appointed? There would certainly have been that risk, and perhaps the Bear board and executives didn't want to risk losing their attorney-client privilege to the trustee or have the scrutiny of an examiner.

Comments

[AMC]

Are you sure that Bear Stearns would have ever (since 1979) been eligible to file a Chapter 11?

Many types of banks are prohibited from filing Chapter 7 under 11 U.S.C. 109(b). And, while broker-dealers can file under the SIPA provisions of the Code, broker-dealers are prohibited from filing Chapter 11s.

Under 11 U.S.C. Section 109(d), eligibility for Chapter 11 is based on eligibility for Chapter 7 - except that railroads can't file 7s, but can file 11s, and broker-dealers can file 7s, but can't file 11s. There is some rather opaque language about certain banking entities, but I don't know that it is clear cut that what is commonly described as an "investment bank" is eligible.

And, of course, that was the $2 question for Bear Stearns.

[Adam Levitin]

AMC makes a very good point. We don't even know if Bear could file for 11. I assume that Bear has multiple entities. It's possible that some are bankruptcy eligible and some are not. Some of the entities might well be 101(53A) stockbrokers, who are only chapter 7 eligible. But other than its brokerage operations, Bear wasn't taking deposits (that I know of) so I don't think Bear's other entities would fall into any of the categories (basically governmentally insured institutions) that are ineligible for chapter 7 and thus for 11.

[Buce]

I wouldn't give up on "bank" so quickly. Much is being made of the fact that Bear is /not/ a bank for FRB purposes, and thus outside the net that justifies the bank exception. Aside from bank, though, some loose thoughts.
--One, as to solvency: I know it is not a formal threshold for Ch 11, but various commentators have been remarking on how Bear is "not insolvent." I suppose they are predicating their judgment on th $270 million equity slice on a $400 bill balance sheet. But I'd regard that as either (a) nuisance money, or (b) a deep out-of-the-money call option: note that capitalized value of traded debt plus the equity $270 almost certainly does not equal face value of debt.
--Two, could a filing be done without shareholder approval? Or could we invoke Henry Paulsen's persuasive muscle?
--A trustee would be an ideal person to prosecute any actions for corporate looting (but quaere whether these would even belong to the estate).
--Would 555-6 + 559-62 make it not worth the bother?
--Would golden parachutes survive a BK filing?

There's more on topic at my own blog link.

[Patches]

Couldn't multiple BKs be consolidated like they did in the ASARCO 11? Someone tell me if I'm wrong but you cant get a discharge in a corporate 7 right? So the brokers have to file as individuals? What if they are an incorporated entity?

[AMC]

From a recent article:

http://www.portfolio.com/news-markets/top-5/2008/03/18/JP-Morgan-Bear-Stearns-Deal-Lawyers#page2

"Several bankruptcy lawyers, who declined to speak on the record because of client relationships with either financial institution, agreed that there was little upside to a Bear Stearns bankruptcy.

The parent company is eligible to file for Chapter 11 reorganization, but many of its businesses are registered-stockholder businesses, which would face Chapter 7 liquidation and sale. "It has no great allure or utility," said one bankruptcy lawyer.

Another said that a Bear Stearns bankruptcy filing would be one of the most complicated and expensive in history. "There are so many transactions, it boggles the mind," this lawyers said.

A third pointed out a bankruptcy filing would not stay or put on hold many of Bear Stearns' outstanding loans, including deals known as "repos" and swaps, because the bankruptcy laws do not allow that."

To the extent some of Bear Stearns' subsidiaries were broker-dealers, their only option would be a Chapter 7 proceeding under SIPA, with the Securities Investor Protection Corporation selecting the Chapter 7 trustee. It would be an unusual SIPA case, since Bear Stearns doesn't have the kind of retail trade that most brokerage bankruptcies have had.

The reference to the repo/swaps problem is 11 U.S.C. Section 362(b)(17) - basically, trades in the financial markets are not stayed. And the kinds of transactions that were part of Bear Stearns business are transactions that happen on a very short timeline - so they would be extremely difficult, if not impossible, to even slow down with a bankruptcy, given the automatic stay exceptions.

Further, filing a Chapter 11 for the holding company would only impose the stay on actions against the holding company, not the subsidiaries - and especially not the subsidiaries that would not even be eligible for Chapter 11.

And the question remains, at least in my mind, whether portions of Bear Stearns would qualify as "banks" under Sections 109(b) and 109(d).

There is also the nightmare bankruptcy scenario for Bear Stearns and the financial markets - important subsidiaries filing for bankruptcy protection under Chapter 11 and being either thrown out, or required to liquidate under Chapter 7 as broker-dealers.

[AMC]

From the SEC's March 18th press release:

http://www.sec.gov/news/press/2008/2008-46.htm

What protects customer funds and securities at broker-dealers?

Bear Stearns' corporate structure includes several broker-dealers registered with the SEC. As a result, notwithstanding the loss in market value in Bear Stearns' stock, and independent of the transaction announced on March 17, many protections remain in place for customers of Bear Stearns' broker-dealers.

Under SEC rules, registered broker-dealers must maintain net capital to provide financial resources so that if the firm fails, customers will get their cash and securities back. Customer claims for their funds and securities are preferred over other claims on the broker-dealer. As a second level of protection, the Securities Investor Protection Corporation (SIPC) guarantees remaining customer securities claims up to $500,000.

Clearly, under the Code, those "several" broker-dealer entities within Bear Stearns were not eligible for Chapter 11.

[AMC]

http://www.freep.com/apps/pbcs.dll/article?AID=/20080321/BUSINESS07/803210378/1020/Business07

Bear Stearns buyout challenged

March 21, 2008

Bear Stearns Cos., the troubled brokerage whose stock has fallen more than 90% this year, was sued by a Detroit pension fund asking a judge to halt a planned buyout for $2.32 a share by JPMorgan Chase & Co.

JPMorgan said March 16 it would buy the shares with an equivalent amount of its stock after a run on Bear Stearns, the fifth-largest U.S. securities firm. The stock was trading at $30 on March 14.

"The sale price does not reflect the value of Bear Stearns" and "shareholders are being shabbily treated given that the transaction was not designed to maximize or even salvage their equity," the Police and Fire Retirement System of the City of Detroit, with 13,500 shares, said Thursday in a complaint in Delaware Chancery Court in Wilmington.

Bear Stearns was once the biggest underwriter of U.S. mortgage bonds.

[AMC]

Who needs Chapter 11 when you can turn $30 Billion in toxic CDOs into treasury bills?

A little Wall Street two step played on the Fed and everybody wins an additional $8 a share, courtesy of the U.S. Taxpayer:

http://news.yahoo.com/s/ap/20080324/ap_on_bi_ge/jpmorgan_bear_stearns

Well, "everybody" but those poor folks getting foreclosed on, but they don't matter because government bailouts are for little people.

So, that bankruptcy bill that would allow bifurcation of mortgages can't be enacted. That would be interference in the free market. Nope. Can't have that.

[AMC]

"are for little people" should be "aren't for little people".