Patterico's Pontifications

3/17/2008

Bear Stearns Deal Could Herald More Than a Bear Market

Filed under: General — Patterico @ 7:18 am



It’s ugly now, to be sure. But if major banks start failing, a recession could be the least of our worries.

62 Responses to “Bear Stearns Deal Could Herald More Than a Bear Market”

  1. Bear, of course, falls outside the purview of the Fed, which is why the funding the Fed extended to them last week was so unusual.

    Since the bail-out of Continental-Illinois back in the 80’s established the concept of “Too Big To Fail”, the Fed will do everything it can to prevent any of the large banks from failure, and has in several liquidity crisis that have occurred since then.

    JPMorgan paid $.07 on the Dollar for Bear, and Bear’s shareholders were probably lucky to get that.

    The hedge fund guys have been flying high for a long time, and now the pidgeons are coming home to roost. I hope they saved some of that money they were raking in.

    Another Drew (f9dd2c)

  2. I didn’t think that Bear Stearns was a bank.

    Techie (ed20d9)

  3. Hedge-Funders are just the first domino.

    Prepare yourself.

    Semanticleo (f828ed)

  4. Prepare for the “Bush Recession,” and the onslaught of liberal media types wailing and never-ending comparisons to the Keating-5 scandal. Whether or not our economy actually takes a significant hit, John McCain’s campaign will, if the liberal media have any say in it.

    Daryl Herbert (4ecd4c)

  5. Drew – I believe Bear Stearns is a primary dealer for government securities and while the FOMC would have no interest in their failure, their activities in that role would be subject to certain Fed regulations. Are you certain they don’t have bank or thrift subsidiaries if such are permitted these days?

    daleyrocks (906622)

  6. WaMu had their bonds rated just above “junk bond” rating by Standard and Poor’s about 10 days ago….I think that they, Wachovia, Citi, B of A and others bear watching over the coming weeks.

    Just my opinion – I think that the banks and lending institutions created this mess by not only pushing their “deals” on home loans, but encouraged builders and contractors to get on board with the housing boom as a way of generating money. Unfortunately, when people could not make payments on their “great loans”, foreclosures increased, and the banks started crying foul and asking for help. If more banks start looking for help, then God help us….

    fmfnavydoc (affdec)

  7. “WaMu had their bonds rated just above “junk bond” rating by Standard and Poor’s about 10 days ago….I think that they, Wachovia, Citi, B of A and others bear watching over the coming weeks.”

    The bond rating downgrade to truly fear is for US Treasuries.

    I hate like hell to buy gold at $1015, but there’s nowhere else to hide now.

    Game over, man.

    gp (72be5d)

  8. daleyrocks…
    No, you are correct, Bear is not a bank, which is what made the Feds action last week so unusual; plus, that probably made it imperiative that Bear find a dancing partner to take care of them on the long-term.

    The securitization of mortgage debt, and the problems resulting from a decline in housing values, is endangering quite a few people. This is another derivitive scare like we saw in the early 90’s which caused the bankruptcy of Orange County, CA.

    Another Drew (f9dd2c)

  9. It’s more properly termed the “Greenspan Recession,” although done with Bush’s support. The supposed prosperity Bush was crowing about was mostly a bubble. Not that the Dems would have done any differently, of course (see Clinton/Greenspan, Tech Bubble).

    Bradley J. Fikes (a18ddc)

  10. So, I don’t have to put up with those annoying DCU and Ditech.com ads on TV anymore?

    There is a silver lining.

    Techie (ed20d9)

  11. My concern meter was inching up reading this. Then, semencleo drops by to tell us how horrible everything is, and I must take a moment to step back and re-assess.

    JD (5f0e11)

  12. Bradley, i’ve been wondering lately to what degree the situation has been made worse by the repeal of the part of Glass-Steagall which established a firewall between banks and investment services.

    That was a decision made jointly by the Gingrich Congress and President Clinton (meaning, if it was a major contributing factor, *nobody* escapes fault).

    aphrael (db0b5a)

  13. lehman brothers is next, and considering how aggressively they telemarketed me back when i practiced law, i will applaud their demise.

    assistant devil's advocate (b6d44f)

  14. WAMU is still rated bank investment grade. Lehamnn has something like 70 billion in cash. When this financial meltdown you Eeyores are predicitng doesn’t happen, will you guys come back and admit you didn’t have any idea what you were talking about?

    spongeworthy (9b4e06)

  15. gp hit the matter on the nose. Ultimately now (vis-a-vis the Fed’s continued panic and discounts), it is the solvency of the U.S. that is at risk.

    I’m stuck on something, though, and seek your help.

    How does a stock plummet from $50/share at Friday’s close to a buyout value of merely $2/share before the market reopens? Since this implosion has come at such a shock to all of us, especially The Street and screwed Bear Stearns investors and employees, I wonder if Bear Stearns hasn’t been a bad boy in the sandbox lately and maybe all along. I find it uncannily convenient for the buyout to be negotiated and the deal struck just moments before Stearns was to provide their abysmal quarterly reporting.

    Doesn’t this suggest a wee bit of securities fraud in nondisclosure or gross understatement of its solvency/insolvency to its investors? How else can value go from $50/share to $2/share practically overnight?

    EHeavenlyGads (f29174)

  16. When life gets tough the worst thing to do is panic, especially during an election year when America is victorious in Iraq.

    securitization of mortgage debt, and the problems resulting from a decline in housing values

    Especially when those housing prices were over-inflated at the time they were sold.

    syn (1017f1)

  17. fmfnavydoc – Don’t forget that good intentioned blackmailing of the lending institutions into “affordable housing,” i.e. riskier mortgage lending, as one of the factors kick starting the current mortgage debacle.

    daleyrocks (906622)

  18. The decline in housing values doesn’t affect borrowers’ ability to pay. It affects collateral values, ability to realize values on foreclosed properties, abilities to continue to tap equity in homes as a source of financing, as well as a variety of other things.

    daleyrocks (906622)

  19. That was a decision made jointly by the Gingrich Congress and President Clinton (meaning, if it was a major contributing factor, *nobody* escapes fault).

    Actually, Gingrich was no longer Speaker when the act was repealed. I don’t think it’s fair to call it his Congress.

    Steverino (e00589)

  20. “Don’t forget that good intentioned blackmailing of the lending institutions into “affordable housing,” i.e. riskier mortgage lending, as one of the factors kick starting the current mortgage debacle.”

    I’d say the problem is the housing is un-affordable. But do say more as to your idea.

    stef (dfd808)

  21. Regarding affordable housing: A hands-off policy by the federal government is the best way to bring it about. Here’s an article about the folly of government-mandated affordable housing.

    In North Park, a curious, but not surprising, thing has happened.

    Developers built a condominium project, La Boheme, in 2006 with 224 units. They set 45 of them aside as so-called affordable units. The builder is selling three of these identical one-bedroom condos for $183,701 each. Not $183,702 and not $183,700. No, the asking price is exactly $183,701.

    They are affordable units, set aside for those with average incomes, as part of a government assistance program that controls their price. Local government must manage and enforce restrictions on who buys these homes, who lives in them and what they do with them over time.

    The other day, as my colleague, the insightful Ms. Bennett, revealed, one of the normal condos in the development — a place whose value is not controlled by the authorities — went up for sale a few weeks ago. This is not the interesting part. Condos in San Diego are like churros in the touristy streets of Baja — they’re being sold everywhere you look.

    What makes this one interesting is that the asking price for it is less than the prices of those homes set aside as affordable. The sellers are asking $168,000 for the condo.

    Yes, it has happened.

    The market, without even trying, just did what the government has spent millions of dollars and hours trying to do. . . .

    Bradley J. Fikes (a18ddc)

  22. EHeavenlyGads

    How does a stock plummet from $50/share at Friday’s close to a buyout value of merely $2/share before the market reopens?

    Truly a puzzler, since everyone knows that Spitzer cleaned up Wall St long ago. Now let’s all toast priorities with a whiskey in this fashionable Martha Stewart shot glass over here.

    ras (fc54bb)

  23. I agree, Bradley, this is a government-run recession. Bush and the Feds wanted to avoid a financial meltdown after 9/11 at all costs. After years of airline bailtouts, speculative lending and open immigration (to gin up consumer demand) we are finding out what “at all costs” really means.

    I have a big yard. I could grow veggies and survive on that for a while….

    Patricia (aaa977)

  24. Bear found a buyer, and they agreed on a mutually beneficial price – one they could both agree to. Who knows what had transpired behind the scenes since the close Friday.
    If they had waited for the market to open, their stock might have faced de-listing, which could mean a complete lack of value.
    When someone throws you a life-ring as you’re approaching the edge of a waterfall, it’s usually a good idea to take it and not quibble about the cost.
    Bradley…that post is priceless.

    Another Drew (f9dd2c)

  25. Follow-up on “un-affordable” housing…
    In the 90’s, the OCRegister did a study on the effect of Gov’t regulation on the cost of new housing in the OC. Their best estimate was that 1/3 of the posted price of new housing was attributable to gov’t imposed mandates, delays, and other devices encountered by a developer; and, had nothing to do with the base cost of land, labor, or materials.
    One-Third! In a market where the mean for new housing was (at that time) a half-mil.

    Another Drew (f9dd2c)

  26. Drew – The government is there to help you, doncha know. It helps in California more than in many other states.

    daleyrocks (906622)

  27. The affordable housing I was referring to was groups of community activists showing up in front of a bank’s headquarters with TV news crews condemning a bank for not making enough mortgage loans in whatever happens to be the undesireable neighborhood du jour. With the increasing ease of loan securitization, the bank can say screw that bad publicity, we’ll make the freaking shitty loans and sell them to some Wall St. conduit and let them deal with the credit headaches. We just don’t want to keep them on our books because we know they are lousy risks. Let somebody else deal with them.

    daleyrocks (906622)

  28. daleyrocks, #27…
    Don’t you know it. It is interesting to read the writings of Thomas Sowell, Walter Williams, and others on these un-democratic distortions of the free-market system.
    First they complain about “red-lining”, now they complain that the consumers were duped into signing bad deals. Damned if you don’t, damned if you do.
    Well, I hope they have a taste for pidgeons.

    Another Drew (f9dd2c)

  29. Steverino, that’s a fair point; i’d forgotten when the handoff from Gingrich to Hastert took place.

    The broader point (that both the Republicans in Congress and the Clinton administration bear responsibility for that decision) stands.

    aphrael (e0cdc9)

  30. In Mission Viejo, we just had a multi-year battle over affordable housing. The deal is that developers fund “public interest law firms” who then threaten to sue small cities unless they build more “affordable”, meaning subsidized, housing. The developer just happens to have a plan for some that ignores zoning, traffic issues and other considerations like master plans. I sat on the planning commission for about half of this battle, which went on for five years. The developer finally won last year just as the housing bubble collapsed.

    Now there is a proposal for the city (the City !!!) to take over the project, bail out the developer who is now broke, and build the affordable housing. The builder’s allies on the city council are behind this monstrosity of a plan and the rest are fighting it.

    Kind of a delicious irony except for the fact that the local tax payers could get stuck with the check.

    That’s how it’s done.

    Mike K (6d4fc3)

  31. The taxpayers ALWAYS get stuck with the check!

    Another Drew (f9dd2c)

  32. Another Drew, you obviously know a whale of lot more than I on the subject. I thank you for the response. You’re completely right — no wrong done, just one HELL of a capitulation.

    But life-rings work best in calmer waters, in which you can paddle back to safety. If you’re headed over a waterfall, that ring had better be tethered to something. Following this mess, how many others will need to seize that tether and just how many can said tether support? Ultimately, the line will break or break free.

    I believe you and others have already clearly conveyed that fact.

    EHeavenlyGads (f29174)

  33. “One-Third! In a market where the mean for new housing was (at that time) a half-mil.”

    So a third of the price was meeting things like minimum code regulations?

    stef (23c2b4)

  34. No stef.
    Most of that money was eaten up by delays to planning approval, due to environemental requirements, traffic mitigation studies, etc.
    It had nothing to due with construction code; it had all to do with environmental craziness, and the pursuit of a perfect world.

    Another Drew (f9dd2c)

  35. stef, read Another drew’s comment again:

    In the 90’s, the OCRegister did a study on the effect of Gov’t regulation on the cost of new housing in the OC. Their best estimate was that 1/3 of the posted price of new housing was attributable to gov’t imposed mandates, delays, and other devices encountered by a developer; and, had nothing to do with the base cost of land, labor, or materials.

    Minimum code requirements are covered in the base cost of land, labor and materials.

    Reading comprehension, stef…look into it.

    Paul (249390)

  36. I agree with Spongeworthy #14.

    DRJ (a431ca)

  37. Doesn’t this suggest a wee bit of securities fraud in nondisclosure or gross understatement of its solvency/insolvency to its investors? How else can value go from $50/share to $2/share practically overnight?

    Heh, yeah. The plaintiff’s bar just sent out a big order for new pencils and the interns are sharpening them as we speak. Probably sharpening at partner rates, too.

    What I don’t understand is how all this buyout stuff could happen without input from the shareholders. I mean, if I own a stock worth $50 on Friday and someone else buys my stock for $2 on Sunday without my input… huh?

    Eric (09e4ab)

  38. Eric – The deal is still subject to shareholder appeoval. They’ll have their chance to vote.

    daleyrocks (906622)

  39. On the news reports tonight I heard that someone has already filed a class action against the old management and directors.

    In response to Eric’s question–I suspect that the number of firms able to pull off a deal of this size, even at the Jefferson per share price is relatively limited. Morgan, in the tradition of its founder, probably made a rock bottom rock bottom offer, in the absence of any viable alternatives for the Bear Stearns board. Two dollars a share is after all better than zero dollars a share, which is where share values were headed.

    kishnevi (d50358)

  40. Drew @ 28 – Is there anything in the plan to indicate that the Feds are taking any pipe here or just providing a liquidity facility in an attempt to maintain orderly markets. I am all in favor of greedy borrowers and lenders paying for their sins rather than the government.

    daleyrocks (906622)

  41. Lots of investment backs go out of business happens about every 4 years since I can remember

    Soloman Brothers – that was supposed to trigger a global depression and a third world war – nawww

    Its just another slow news day

    Kidder/Peabody – anyone remember the endless commericals – gonee in 60 seconds

    Again was supposed to be the heralding of global tsunami’s of failures

    nothin

    EricPWJohnson (d2733c)

  42. Banks, lots of investment banks, sorry

    EricPWJohnson (d2733c)

  43. Here, this may help to understand the behind the scenes on this deal. Dan Amoss is an market analyst with this recent explanation…

    In reality, the Federal Reserve is buying Bear. All of the capital J.P. Morgan will use to buy the brokerage house is being borrowed. The Fed is putting up $30 billion in cold cash to help shore up Bear’s balance sheet.

    “J.P. Morgan and the Fed are stepping in,” Dan Amoss explains, “because they realize the type of liquidity crisis that would unfold if they do not.“ J.P. Morgan is likely a monstrous counterparty to derivative trades with Bear Stearns, and could find itself in the s$!t, too, if Bear starts defaulting.”

    But more than that, “the bailout is an effort to keep the financial system functioning,” Amoss says. The Fed needs to keep up appearances “until their TSLF is implemented at the end of March. They intend to keep Bear Stearns on life support for the next two weeks, not bail out BSC shareholders.”

    Further, Bear Stearns was the only major Wall Street investment bank that did not participate in the Long Term Capital bailout back in the 90’s. To the consternation of the Treasury and the other investment banks, Bear risked nothing in that action, but reaped the resultant benefits. Seeing as how this latest JPM and Fed setup with Bear would not have been necessary, and Bear would still be in business, if this kind of ‘loan’ had gone directly onto their ledger last week, one might leap to the conclusion the big boys do hold grudges for a long time with retribution always in the wings. And with JPM, an in-crowd player, perhaps at major risk of its own demise maybe that explains their role in this. Conjecture only on that aspect.

    There’s more I could add, but this is long enough for a comment.

    allan (8e5ee9)

  44. Here’s my understanding of what happened:

    Bear Stearns essentially had a run on the bank because its trading partners were worried it had overvalued its non-liquid assets and did not have enough cash to settle up. However, because Bear Stearns is not a national bank, the Federal Reserve could not directly make funds available even if Bear Stearns had sufficient collateral.

    JPMorganChase, a national bank, apparently agreed to be the conduit for advancing a secured line of credit controlled by the US government:

    “In a highly unusual maneuver, Fed officials said they would secure the loan by effectively taking over the huge Bear Stearns portfolio and exercising control over all major decisions in order to minimize the central bank’s own risk.”

    I suspect JPMorganChase agreed to this on the condition that Bear Stearns would be sold as opposed to going into bankruptcy/receivership. There aren’t a lot of banks that could do this, and it was reported that JPMorganChase already had knowledge of Bear Stearns’ portfolio and audit information so it knew what it was buying beforehand. No doubt JPMorganChase was able to use its position and knowledge as leverage to hammer on the sale terms.

    This looks like a bonanza for JPMorganChase. For instance, Bear Stearns owns a $1B 47-story building in NYC and JPMorganChase is in the market for new offices. It’s been reported that the Bear Stearns’ building alone would justify a Bear Stearns’ share price of $8/share. Bear Stearns would have to have a portfolio of big losers to offset that asset. Instead, it has other assets that are desirable to JPMorganChase. However, it’s not unusual for those with cash to be able to make good deals when the seller has to sell quick.

    Of course, this is bad news for Bear Stearns’ stockholders and employees but they also made a lot of money during the booming hedge fund and mortgage years. As a hedge fund broker and mortgage underwriter, Bear Stearns and its shareholders and employees profited handsomely. I don’t say that to downplay the hardship some may suffer but, just as the markets often reward those who take the most risk, risk-takers are often the hardest hit when markets change.

    FWIW, I heard on a business show today that the JPMorganChase terms reserved $6B to settle lawsuits. If that’s true, this may not be as bad for the employees as it was in Enron.

    Finally, this may end up spreading to similarly-positioned entities but it’s not clear it will. At this point, I agree with this article that, so far, Bear Stearns is primarily about liquidity, not solvency.

    DRJ (a431ca)

  45. “Minimum code requirements are covered in the base cost of land, labor and materials.”

    I read minimum code requirements as increasing the amount of inputs required, so it wouldn’t be the “base” cost. Base is cost without regulation.

    Looks like we need a link. I’d like to read about who has money to invest in a business where 1/3 of their cost is delay, and then doesn’t hold their money somewhere interest earning during that time.

    stef (300532)

  46. DRJ,

    If this is just about liquidity, then wouldn’t assigning a negative value to Bear Stearns’ non-real estate holdings be a little excessive? Also, wouldn’t someone like Warren Buffett have made a bid for the company in that case? Buying illiquid assets at fire-sale prices is the kind of thing he loves to do. The absence of competing bids for Bear Stearns speaks volumes.

    Bradley J. Fikes (1c6fc4)

  47. There were other interested parties. It was simply too big a transaction for others to compete on such short notice.

    DRJ (a431ca)

  48. There were also reports that other private equity firms were interested, such as Kohlberg Kravis Roberts & Co. But no one had a handle on Bear Stearns’ liabilities like JPMorganChase did, and it’s too hard to cover all the bases in a transaction of that size in just one day.

    Furthermore, it takes significant capitalization to do a transaction of this size, even if it is “just” $2/share. Citigroup already has mortgage exposure and doesn’t need what Bear Stearns had to offer, while Bank of America is in the process of bidding on Countrywide.

    DRJ (a431ca)

  49. Bradley – Without knowing more about Bear Stearns’ positions, it’s tough to make comments about the assignment of values. Clearly time was of the essence. The big Wall Street mortgage firms had all shopped their mortgage portfolios to each other looking for deals in the past or had sold similar products so there was an element of familiarity there. DRJ is right on the money there. Assembling a group of LBO type buyers would have taken too much time.

    Has Buffet done a Wall Street deal since his Salomon days? I forget. I don’t think he’s real big on credit default swaps and other esoterica that look like they may be hitting the skids.

    daleyrocks (906622)

  50. Bradley,

    I’m not a finance expert and it’s good to be skeptical about this because Daleyrocks is correct that we don’t know enough of the details to say anything for sure. However, there’s another reason why this purchase may be better for JPMorganChase than it would be for other potential sellers. (I suspect it’s why JPMorganChase was apparently targeted to be the buyer.) I mentioned it in passing but I’ll try to address it more clearly now.

    As I understand mortgage lending, banks like JPMorganChase and other financial institutions have mortgage lending divisions that finance residential purchases through secured loans. These institutions typically transfer the loans to mortgage underwriters like Bear Stearns for funding and servicing. However, since the financial institutions retain contingent liability for the loans, they also have the right to monitor and audit how the loans perform.

    It’s been reported that Bear Stearns was the underwriter for many JPMorganChase mortgage loans and that’s why JPMorganChase was familiar with some of Bear Stearns’ portfolio. If so, then JPMorganChase already had potential/contingent liability for some of the mortgage loans underwritten by Bear Stearns. In my view, that would make an immediate purchase more attractive to JPMorganChase than it would to potential purchasers like Warren Buffett. Why? Because JPMorganChase not only knew more about the liabilities, it already had contingent liability on some of the loans. Other purchasers would have been assuming liabilities they were not already obligated on.

    DRJ (a431ca)

  51. Good analysis, DRJ / Daleyrocks.

    SPQR (26be8b)

  52. DRJ – I suspect JP Morgan was a large provider of credit to Bear Stearns, which also gave them substantial insight into their operations. I’m not sure I buy into the contingent obligation theory, though. I believe most mortgages are sold without recourse, although a seller may hold onto a tranche of a pool of mortgages that are tough to sell or they believe are attractively priced. They bear similar default risk as other investors, but it is not the same as recourse sales. Banks, which have to maintain regulatory capital ratios, might find it tough to plan for the contingencies of which you speak – it would be almost like not selling the loans in the first place and they might have to set capital aside for the potential obligations. The servicing rights, of course can be separated from the underlying loans and sold or retained separately.

    daleyrocks (906622)

  53. I read minimum code requirements as increasing the amount of inputs required, so it wouldn’t be the “base” cost. Base is cost without regulation.

    Really?

    Do you know of a developer/builder who doesn’t plan for meeting minimumn code requirements at the blueprint approval stage?

    Paul (249390)

  54. Good analysis, DRJ / Daleyrocks.

    I agree. Excellent job!

    Paul (249390)

  55. “Do you know of a developer/builder who doesn’t plan for meeting minimumn code requirements at the blueprint approval stage?”

    I doubt there are many builders that dont’ plan on meeting regulatory requirements at all stages of planning and building.

    stef (688568)

  56. DRJ/daleyrocks,

    Thank you for those explanations.

    Bradley J. Fikes (1c6fc4)

  57. DRJ/daleyrocks,

    Thank you for those explanations.

    Very much.

    EHeavenlyGads (f29174)

  58. Bear/JPM…
    One thing nobody has mentioned, but was on Fox News, is that 1/3 of the shares in Bear-Stearns are held by employees. Therefore, I think it is safe to assume, that the “players” are being hurt with the loss in value of their personal holdings, and stock-options, etc.

    Another Drew (f9dd2c)

  59. stef…
    For more info on OC land regulations, you can go to the Register website http://www.ocregister.com, and search the archives for columns by Jonathan Lansner (who covers real estate for their business section), or email him and ask for a link, jlansner@ocregister.com.

    Another Drew (f9dd2c)

  60. Daleyrocks,

    You are probably right that Bear Stearns purchased mortgage loans without recourse but I heard reports (and they may have been wrong) that some Chase loans were sold with recourse.

    DRJ (8b9d41)

  61. I doubt there are many builders that dont’ plan on meeting regulatory requirements at all stages of planning and building.

    Guess what? Regulatory requirements are figured into the base cost.

    Gotcha.

    Paul (249390)

  62. Wrapping this thread up, there were apparently other potential bidders at the weekend Bear Stearns’ meeting:

    “The trio, along with Bear chief executive Alan Schwartz and chairman Jimmy Cayne, welcomed a series of potential buyers to the 777ft tower block, with banks including Barclays and Royal Bank of Canada represented, in addition to private equity firms JC Flowers and KKR.”

    This morning’s business shows speculated that Barclays is still interested in bidding if the shareholders refuse to approve the sale to JPMorganChase.

    DRJ (a431ca)


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