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Loaded for Bear?

posted by Adam Levitin

Last week, JPMorgan was going to pay $2/share for Bear, Stearns, with any loss absorbed by the Fed (and thus by taxpayers). Now JPMorgan is going to pay $10/share.

This new offer shows what a lowball offer $2/share was. The offer just jumped 500%! This should make one question whether $10/share is still a lowball. Can we expect the current process to produce a fair market price for Bear? Shouldn't we at least have some sort of an auction? Perhaps that already happened informally before the JPM bid came out, but now that the initial panic has subsided, maybe it's time to have a more formal and orderly auction. In light of the apparent drafting snafu in the original offer that has JPM on the hook for all of Bear's trades, regardless of whether the deal is consummated, I have to think the Bear Stearns board might have a duty to shop for other offers. I assume that the Fed would offer its guarantee to anyone who could top the JPM offer.

Regardless of whether JPM pays $2 or $10/share to eat Bear, I'm still puzzled why the Fed didn't guarantee BS directly or buy it out itself? Why would the Fed take the downside risk, but not also the upside? I'm not familiar with the Fed's enabling statute--perhaps there is a legal impediment. But even if not, I doubt that the Fed wants to own BS itself--it's one thing to hold some mortgage backed securities, it's another thing to have a 100% stake in a major investment bank, even for a short period. Still, it's one thing to bail out Bear Stearns. It's another to hand JPM (or anyone else) a windfall that should rightfully be the taxpayers'.

Comments

Don't you get it? It's not the *Fed* who's bailing out Bear, it's *JPMorgan.*

The Fed? Oh, they're just some lender here. Nothing to see. Move along.

This entire deal has a very foul odor about it. I think we need to give the Bear a complete scrub-down and see what is really under that dirty coat of hair.

Jonathan Lipson posts a bankruptcy related answer to this question (or a question much like it) here:

http://www.concurringopinions.com/archives/2008/03/lipson_on_the_b_2.html

As I understand it, the Fed does get the upside -- of the questionable assets backing the $29 billion guaranty. The WSJ speculated the other day that the Fed might actually end up making a profit if it just has the stomach to hold what it gets. Don't know if that's just whistling in the wind or not.

It did occur to me that, with JPMorgan essentially locking up this acquisition with a guaranteed 39% stake and a lock up on the skyscraper, were the same thing to have occurred in bankruptcy, few courts would have approved the sale.

I think the stockholders are blackmailing the Fed. JPM almost certainly doesn't really want the company and the Fed had to assume the risk to get them to take it. The Fed midwifed the deal to prevent the collapse of other investment banks that depend on BS as a counterparty to maintain their own balance sheet fictions.

You are absolutely right that nobody knows what Bear Stearns is actually worth. And nobody really wants to find out, either. Because this is a "sale" and not a "bankruptcy," the deal needs the approval of the stockholders and not a bankruptcy judge (who would almost certainly be asking quite a few tough questions himself). The stockholders might well have done better in a bankruptcy court.

But we'll never know, will we? This has nothing to do with the merits of the buyout and everything to do with shoring up a very shaky financial system built not just on "liar loans" to amateur real estate speculators, but on spectacular "liar CDOs" traded back and forth between major banks to create enormous paper profits. Like any currency, these financial instruments become worthless the moment people lose faith in them. This is what has the Fed scrambling to keep BS out of the reality-based world of bankruptcy courts.

The key question is how reflective the market value of stocks is of their underlying value. If the Bear Stearns market evaluation is typical of many stocks, we are potentially facing an extremely deep recession or even another Great Depression.

Cheers,
Bail y

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