Per the Times, JP Morgan is in negotiations with Bears Stearns and the Fed; in an attempt to prevent a shareholder revolt JP Morgan may raise its offers for Bear Stearns shares from $2 to $10. The Fed is balky because it has been claiming that $2/share is not a Federal bailout; that is a less compelling position at $10 per share. BSC closed at about $6 on Thursday.
This is outrageous, but not surprising:
Mr. Dimon became increasingly desperate in recent days. He offered certain employees cash and stock incentives to stay on and made calls to his rival chief executives on Wall Street — John J. Mack at Morgan Stanley and John A. Thain at Merrill Lynch, among them — pleading with them not to recruit Bear employees during the transition.
The NFL has rules restricting free agents; Wall Street does not.
This is funny and surprising:
JPMorgan and Bear were prompted to renegotiate after shareholders began threatening to block the deal and it emerged that several “mistakes” were included in the original, hastily written contract, according to people involved in the talks.
One sentence was “inadvertently included,” according to a person briefed on the talks, which requires JPMorgan to guarantee Bear’s trades even if shareholders voted down the deal. That provision could allow Bear’s shareholders to seek a higher bid while still forcing JPMorgan to honor its guarantee, these people said.
Mistakes were made! Now, that non-extinguishing guarantee does sound bone-headed, but I have read elsewhere that JP Morgan was granted an option on the Bear Stearns headquarters in midtown Manhattan; maybe this guarantee was in consideration of that option, hmm? Tell it to a judge.
Meanwhile, Fed action has raised the value of Bear's assets, and the new liquidity facility is available to Bear creditors. Maybe Pauline, having been pulled from the tracks, won't ride off with the hero.
MORE: Don't like the Perils of Pauline? How about, now that we have all clapped and Tinkerbell is revived, she has flown out of Peter's grasp?
IF MY CAT WERE A DAY TRADER: My bold prediction this morning (OK, not bold enough to be heard by humans...) was that Bear Stearns stock would go to $12 on this story. It opened at $9.92 and is now at $12.54.
NUMBERS: Per Calculated Risk the share price is incidental to other merger expenses, so even at $10 its no big deal:
JPMorgan estimated the transaction-related costs of approximately $6 billion pretax. This included litigation, cost of de-leveraging, conforming accounting and consolidation. The $2 per share price was almost irrelevant compared to the other costs - the $2 per share was approximately $236 million.
Changing the deal to $10 per share increases the purchase cost from about $6.25 billion to about $7.25 billion, and will probably help obtain shareholder approval (a serious problem at $2 per share). This isn't a huge difference for JPMorgan, but it makes a significant difference to Bear shareholders.
Based on market movements in the past week Bear's assets are worth more - hey, a big win for the Fed! Should that windfall go to Bear Stearns, JP Morgan, or we the People, via the Fed?
Why choose? I see the Fed reducing its formal guarantee to Morgan, Morgan paying a bit more, and the Bear people taking the deal.
And in my world, a Fed official would promise the Bear people that he will loose the hounds and exhort every regulator and state or Federal prosecutor in America to put Bear and its officers under a microscope if they hold this deal up. Even if the officers win, they lose. Call it the Gitmo option, although in this case the Bear officers (here it comes) Git-less.
It does seem notable that, while the initial reaction to the Fed intervention was positive, that positive reaction lasted all of about one day. The Fed thought it was heading off a panic, but after that brief one day of positive response there has been a growing view that the Fed overreacted--perhaps even panicked on its own. We'll see how this plays out. For example, will the 'mistake' in the contract cancel out the advantages for JPMorgan that were also written in?
Posted by: anduril | March 24, 2008 at 09:31 AM
I seem to remember that TM wondered what would happen if the Bear shareholder refused to sell for $2, but the "one sentence" thing is just too much.
Posted by: Neo | March 24, 2008 at 09:48 AM
Sebastian Mallaby has a column in the WaPo this morning (go to RCP for the link) re "financial engineering" and the Bear collapse. In the article he discusses two classes of winners and losers in the Bear intervention. And, while he terms the Fed intervention "necessary," he worries that the Fed has weakened incentives for monitoring risks:
Posted by: anduril | March 24, 2008 at 09:48 AM
The Fed, typical bail-out people.
====================
Posted by: kim | March 24, 2008 at 10:04 AM
A glimmer of light at the end of the tunnel and it ain't a train coming at you.
Existing home sales are up 2.9% for the month of February.
Posted by: glasater | March 24, 2008 at 10:05 AM
The WSJ's law blog assesses the shareholder's prospects in a discussion with Gordon Smith, a professor at BYU Law School: How Would Shareholders of Bear Fare in Delaware?. Here's the lead in:
If you want to find out what the professor said, go read it yourself.
And then there's the Deal Journal's discussion: Did The Fed Push Bear Into a Bad Deal? The authors discuss "Did the Fed do the best it could with what it knew, or did it act too forcefully to broker a deal that has turned out to be a disaster for Bear’s shareholders?"
Among other comments:
Posted by: anduril | March 24, 2008 at 10:34 AM
I've pointed out the inconsistency of the Administration's supposed laisse affaire
policies; re the Bear Stearns bailout. It appears now that JP Morgan was deliberately
shorting the stock. No way the firm's non
subprime assets could be that low. But their were real concerns that BSC collapse could affect the overall financial picture.
Posted by: narciso | March 24, 2008 at 12:34 PM
Why settle for $10 now? Think Bear Sterns can stall even longer while the Fed and JPM have guaranteed BS trades?
Maybe they can get back to $30?
Posted by: danking70 | March 24, 2008 at 01:06 PM
Probably so, ask Bob Rubin as head of
Citibank Europe, was schlepping the same
grade of securities to the misfortune of
institutions like Northern Rock; logically
he'sthe perfect choice to solve the problem.
Posted by: narciso | March 24, 2008 at 01:09 PM
Of course JP was shorting the stock, so where all the other smart people. The dem feds should stay out of the markets. Should the foreign buyers of Merrill be more worried now that everyone went long before the feds complained? Is this Bill's democracy and how all those Americans got paid? Will hillary save us and should foreign buyers be worried again?
Citi is all CIA and they squeezed China on all that debt. Now, dem feds wants Citi to run the Merrill buys?
Posted by: Pg | March 24, 2008 at 01:27 PM
David Bernstein at the Volokh Conspiracy takes a look at the "inadvertently included" sentence. The comments there are recommended.
Posted by: Shelby | March 24, 2008 at 01:34 PM
David Bernstein at the Volokh Conspiracy takes a look at the "inadvertently included" sentence. The comments there are recommended.
Posted by: Shelby | March 24, 2008 at 01:37 PM
Didn't the Fed facilitate a bailout of a hedge fund during the Clinton Administration ?
Posted by: Neo | March 24, 2008 at 07:46 PM
I think they bailed out Mexico in '94.
Posted by: glasater | March 24, 2008 at 08:10 PM
And Rubin then head of the National Economic Council ; lobbied for the bailout, despite his holdings in Mexican investments.
Half a dozen years earlier, he engineered the takeover of Houston Natural Gas with
another company, His choice for CEO was a well respected government bureaucrat with
some experience in the Texas oil fields. In fact, besides, Boone Pickens was the only one who made money in Texas oil; that fellow
was Ken Lay and the new company was called
Enron.
Posted by: narciso | March 24, 2008 at 09:29 PM
Neo-
Didn't the Fed facilitate a bailout of a hedge fund during the Clinton Administration?
LTCM
The US greased the skids for the IMF bailout packages (SK's was the largest I believe) during the Asian Financial Crisis.
The Fed's charter includes the orderly functioning of markets-if Bear collapased it could have forced others to fall as well and would have been highly disruptive in any event. I would note (with the caveat that correlation is not causality) that gold and oil have come off their highs and the dollar has strengthened since the Fed's Bear Stearns action-even with a rate cut thrown in the mix.
Posted by: RichatUF | March 24, 2008 at 11:34 PM
The other thing I would note is that Treasury has a new agreement regarding "sovereign wealth funds" during the Bear Stearns news cycle.
Posted by: RichatUF | March 24, 2008 at 11:40 PM
Fortune has an article explaining the Bear Rally, and the revised Bear Deal: Bulls run wild at Bear Stearns:
The stock's rise says investors are betting on an even better deal, but this time JPMorgan's hand looks much stronger.
Here's the passage in which JPMorgan's stronger hand is described--and the bad news for shareholders considering trying to scupper the deal:
It occurs to me to ask, in the unlikely event that this deal winds up before a court, would that court be likely to overturn or require a revision of a deal that was brokered by the Fed? How much deference would a court be likely to show, given the centrality of the Fed's role and the Fed's claim that their actions were required to stave off a financial market meltdown?
Posted by: anduril | March 24, 2008 at 11:40 PM
Take the classic (simple) interest rate swap of fixed-for-floating. (This would be the sort of position that a responsible, diligent mortgaqe holder would take in order to hedge the risk that the value of the fixed-rate mortgage is fixed while interest rates float.) The value of the the swap at each coupon is the difference between floating and fixed. In any reasonable expectation of future events, that difference is an order of magnitude lower than the value of either side of the swap.
So the risk in a bankruptcy is not that the swap will be cancelled and rendered worthless, but that it will be half-cancelled, and become a huge liability to the counterparty. Enough of those, and the most exposed counterparty goes bankrupt. And then, like dominoes, they all go down.
That's not the problem with swap positions at all. The problem is that a bankruptcy court could rule the pay side of the swap as liabilities (and cancel it) and the receive side of the swap as an asset and hold the counterparty to it.Posted by: cathyf | March 24, 2008 at 11:42 PM
Well, but cathyf, doesn't it remain that these clients have received a break--the danger to their position, one way or the other, has receded? And this deus ex machina intervention by the Fed (I say that because it was unprecedented) undermines the traditional incentives to monitor risks.
BTW, feel free to explain swaps and derivatives--I haven't a clue.
Posted by: anduril | March 25, 2008 at 12:07 AM
Rich, this is the WSJ's explanation of the commodity price break:
From their lead editorial today.
http://online.wsj.com/article/SB120631534181458205.html?mod=opinion_main_review_and_outlooks
Posted by: anduril | March 25, 2008 at 12:14 AM
Tomorrow's WSJ editorial seconds Fortune's take on the revised deal:
Posted by: anduril | March 25, 2008 at 12:19 AM
sorry
Posted by: anduril | March 25, 2008 at 12:20 AM
Here's what I wanted to emphasize:
J.P. Morgan agreed to quintuple his price, to $10 a share from the firesale value of $2, in return for enough shares to guarantee that the merger will now be approved by Bear shareholders.
and
This makes us wonder if Treasury Secretary Hank Paulson isn't already preparing to cave to Congress on the larger bailout.
Posted by: anduril | March 25, 2008 at 12:22 AM
The action of the Fed seems to be classic 19th century British Central Bank when a panic occurs. The Economist frequently has the quote of their founder endorsing this. The key is that the Central Bank has accepted the notes as collateral though not lending to full face value; they still owe the money. Oddly enough JP Morgan, the man, did a similar thing in the panic of 1905 was it? The issue is liquidity; to loan to homeowners would be different. It would attempt to deal with a solvency problem like food stamps does.
Posted by: michael | March 25, 2008 at 12:46 AM
michael-
...the panic of 1905 was it...
The 1907 Panic [4 meg .pdf]
JP Morgan also was part of the bailout during the Panic of 1893
Posted by: RichatUF | March 25, 2008 at 07:13 AM
OK, I've been hammering away, saying that Republicans need to get ready for the economy issue if they want to win in November. Well, here are two "progressives" who are also worried--about the Dems: Democrats and the Economy. Here're the high points, which just may have something in them for the GOP as well:
Posted by: anduril | March 25, 2008 at 09:29 AM
Two unexpected phenomena are peeking their bright little rays over the morning horizon, too, Anduril.
One, desperate international pessimism over global warming and carbon capping are going to be alleviated in the coming years as the globe cools, and the carbon fever subsides.
Two, by and large it is liberals and Democrats who are most avid for carbon encumbering and blaming man for climate. This is understood by the great muddle, who will be more amenable to persuasion by Republicans as a result.
============
Posted by: kim | March 25, 2008 at 09:40 AM
kim, I agree that Republicans should get a backbone and aggressively make "global warming" an issue. I think it's a winner.
Wayne Jett has a worthwhile article: Investment Bank of Last Resort.
Jett argues several points:
1. The credit crisis was brought about, in part, by Fed policy. In other words, the Fed isn't entirely a white knight coming to the rescue.
2. Current Fed actions appear designed to avoid permanently increasing the money supply (Rick made this point at least a week ago).
3. Bush needs to get involved to steer the Fed into longer term sensible policies. Evaluate it yourselves.
Posted by: anduril | March 25, 2008 at 10:03 AM
I have some doubts as to the election hingeing upon McCain's understanding of monetary policy. If he knows any more about it than the great muddle, that fact has been carefully concealed to this point.
The muddle's state of mind re the economy is tied to the unemployment rate, price of gas and CPI reports. That's for the sharper of knives in a drawer which provides few tools suitable for cutting anything but butter.
JPM's bout of indigestion provides some amusement but not quite as much as the idiotic writing concerning "steep declines" in the price of houses which hold the "median" up as the grail of evidence without mentioning that the jumbo loan window remains closed. The muddle will gobble up the misinformation and be amazed at the results when the jumbo window opens again and the "median" jumps accordingly.
Playing the muddle like a fiddle is McCain's task and he's doing just fine at the moment. Not unexpectedly.
Posted by: Rick Ballard | March 25, 2008 at 12:14 PM
Understanding of monetary policy may not be crucial in the election--but the "progressives" I quoted above are not recommending making monetary policy an issue anyway. They're recommending, if I read them right, putting out a message of optimism and commitment to success, as opposed to a message of pessimism and just surviving. That probably means they'll be touting hope, fresh blood and competence and moving beyond policies that have led to a credit muddle.
What I'M suggesting is that McCain needs to go beyond his standard message of cutting waste and raising taxes--you can argue with the fairness of that characterization, but there's enough in McCain's past to muddy the waters on those issues (as there is with virtually any Senator who has a track record--guess who doesn't have much of one and will try to wield that lack like a sword?). What McCain needs is a semi-coherent commitment to growth and success.
As for housing prices, we're getting close to only half a year to go to the election--six short months. Banks will be aggressively seeking to unload homes they've foreclosed on, and that will almost certainly bring the average price down. That's not a reason for doom and gloom, but is a potent weapon for disinformation of the type that we've seen in past elections. McCain needs to be ready to counter this with a message of growth and success--not just cutting spending and raising taxes. In fact, while fiscal responsibility is always a winner, I believe McCain should be arguing for lower taxes and a reformed tax system to maximize the effect of the growth and success message that I hope he puts out before the public.
Posted by: anduril | March 25, 2008 at 12:33 PM
I roughly agree Anduril. Just not on the timing. This campaign is going to be about boredom (among other things) and coming out early with specifics would, IMO, be a killer.
The two recent examples of elections where the economy was a major issue ('80 and '92) involved an incumbent. McCain has no responsibility for the economy and can afford to wait and watch for a bit. Besides, I shudder when thinking about him applying that mediocre intellect to any particular problem. Better to let the brighter around him lead him slowly to the water and wait patiently for him to drink.
Posted by: Rick Ballard | March 25, 2008 at 12:46 PM
It's not clear to me that I've ever suggested McCain should be butting into the continuing Dem debacle--I just keep saying things like (see above) "McCain needs to be ready to counter" the economy based attacks that are sure to come later. Of course there's no point in getting out in front on an issue that's still developing. This is a time for learning, in an area in which McCain has never shown any previous interest.
Posted by: anduril | March 25, 2008 at 01:33 PM
For a little educational break, how subprimes work in 45 stick figure drawings
Posted by: cathyf | March 25, 2008 at 04:34 PM
For a little educational break: how subprimes work in 45 stick figure drawings
Posted by: cathyf | March 25, 2008 at 04:37 PM
Well, cathyf, I admit it--I can see I've been a chump all my life. Living within my means, paying my mortgage every month, saving for my kids education, never taking vacations, only borrowing for essentials. I should've been an investment banker, one of the really smart guys. I could've had it all.
One question: where does the Fed come in? Heh. There was no stick man for them.
Posted by: anduril | March 25, 2008 at 05:36 PM
Heh--Cathyf--your link is a five chuckler!!
I loved the line--
"Gee, we didn't see that coming."
Posted by: glasater | March 25, 2008 at 06:44 PM
I thought the exchange between the outraged citizen and the accountant was priceless--it comes up so unexpectedly, but kinda sums up the attitude of professionals toward the public.
Posted by: anduril | March 25, 2008 at 07:46 PM
Per the WSJ:
"Demand for expensive goods fell 1.7% in February, an unexpected decline, while a barometer of capital spending by businesses tumbled 2.6%, a second straight drop. Meanwhile, new-home sales slid 1.8% in February to the lowest mark in 13 years, while the median price also declined to $244,100."
More reason to believe the economy will be an issue this fall.
Posted by: anduril | March 26, 2008 at 10:25 AM