Research Update: Bear Hugged
The world did not have to wait too long for Bear Stearns to get hugged. It’s not suprising that JP Morgan Chase (NYSE: JPM) emerged from the forest with its arms around Bear. What was more shocking was the fire-sale price, the $30-billion “dowry” guaranteed by the matchmaking Fed and its associated discount rate cut.
The New York Times provides a good summary of the deal and Andrew Ross Sorkin analyzes how it was put together. “Wall Street was stunned by the news on Sunday night,” he writes.
“This is like waking up in summer with snow on the ground,” said Ron Geffner, a partner Sadis & Goldberg and a former enforcement lawyer for the Securities and Exchange Commission. “The price is indicative that there were bigger problems at Bear than clients and the public realized.”
Sorkin writes” The agreement ended a day in which bankers and policy makers were racing to complete the takeover agreement before financial markets in Asia opened on Monday, fearing that the financial panic could spread if the 85-year-old investment bank failed to find a buyer.”
Those efforts may have been for naught as the news was greeted with another plunge in the markets, in Asia and Europe, no doubt spooked by the broader implications of a $2-a-share purchase price for Bear. The US markets saw the deal in a more positive light, stabilizing after an early selloff.
The Wall Street Journal’s Dealbook says the price tag effectively values Bear at zero. And the FT’s Lex says “the crisis at Bear Stearns has put everybody on red alert. The firm’s near collapse on Friday showed that, in today’s febrile environment, once counterparties lose confidence in a bank, the rush to the exit can quickly become a self-fulfilling prophecy.”
If another broker loses the confidence of investors and counterparties, the Fed will be on the hook again. But, if there is a next time, it is not obvious which of the big banks would ride to the rescue. Their balance sheets are already seriously constrained, and Bear was the smallest of the leading Wall Street firms.
FT Alphaville has a roundup of blog comments on the deal. Portfolio.com’s Felix Salmon thinks the deal is good for the markets and JPMorgan but has harsh words for Fed Chairman Ben Bernanke.
While Jamie Dimon has shown himself to be decisive and opportunistic this weekend, Ben Bernanke looks increasingly like a schmuck who’ll do anything Wall Street asks him to do.
The rating agencies give the deal a cautious welcome.
Rumors abound as to how many more shoes there are to drop, both in terms of larger writedowns and possible rescues of financial firms. Some clarity may be provided when firms announce their quarterly earnings. The Daily Telegraph reports that Goldman Sachs (NYSE: GSC) on Tuesday will announce a $3 billion write-down, “based partly on the declining value of its 4.9 per cent stake in Industrial & Commercial Bank of China (ICBC), which is held separately on Goldman’s balance sheet.”
Despite the multi-billion dollar hit, Goldman will point to the fact that its exposure to the deteriorating mortgage market remains minimal, according to people close to the bank.
In its preview of quarterly broker earnings, CreditSights estimates Goldman’s first quarter write-downs of debt instruments at $1.5 billion.
Noting that Wall Street is braced for buyout loans pain, the Financial Times points out the discrepencies among banks in how they have treated write-offs. “Analysts at Lehman calculate that Morgan Stanley has been the most aggressive, writing down its leveraged loan portfolio to 91 per cent of face value by last November. Barclays has taken a hit of just 2 per cent.
And in an equisitely timed commentary in the FT, former Fed chief Alan Greenspan says “We will never have a perfect model of risk.” Greenspan claims sophisticated financial models don’t take into account “irrational exuberence” or its corollary, un-rational fear.
“The most credible explanation of why risk management based on state-of-the-art statistical models can perform so poorly is that the underlying data used to estimate a model’s structure are drawn generally from both periods of euphoria and periods of fear, that is, from regimes with importantly different dynamics,” Greensapn writes.
“The contraction phase of credit and business cycles, driven by fear, have historically been far shorter and far more abrupt than the expansion phase, which is driven by a slow but cumulative build-up of euphoria. Over the past half-century, the American economy was in contraction only one-seventh of the time. But it is the onset of that one-seventh for which risk management must be most prepared. Negative correlations among asset classes, so evident during an expansion, can collapse as all asset prices fall together, undermining the strategy of improving risk/reward trade-offs through diversification.”
“If we could adequately model each phase of the cycle separately and divine the signals that tell us when the shift in regimes is about to occur, risk management systems would be improved significantly. One difficult problem is that much of the dubious financial-market behaviour that chronically emerges during the expansion phase is the result not of ignorance of badly underpriced risk, but of the concern that unless firms participate in a current euphoria, they will irretrievably lose market share.” So now he tells us.
You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
March 21st, 2008 at 11:58 am
[...] popular Roundup and Update posts featured extensive analysis of JPMorgan’s Fed-sponsored Bear raid. This story will run [...]