Bear Stearns Buyout Under the Microscope

On the night of Sunday, March 16, J.P. Morgan announced that it was buying investment bank Bear Stearns for $2 per share, payable in shares of J.P. Morgan. The price, which values Bear Stearns at $236 million, is more than 90 percent below Bear Stearns' closing price on Friday.  Indeed, the price is almost 99 percent below Bear’s all-time high trading price of $172.61 per share, set a mere 14 months ago in January 2007, when the company’s market value was more than $20 billion. J.P. Morgan announced the deal through a press release on March 16, and held a conference call to explain the transaction. A replay of the conference call is available through March 31 at (888) 348-4629 (domestic) or (719) 884-8882 (international) with the access code 614424. The replay will also be available on www.jpmorganchase.com.

In trading on Monday, March 17, Bear Stearns stock traded between $3.50 and $5 per share, significantly above the deal price. This indicates that traders expect a higher bid to emerge. J.P. Morgan traded 10 percent higher, indicating that investors believe J.P. Morgan is acquiring Bear Stearns at an attractive price.

The Wall Street Journal writes that major 21st-century institutions have evolved from being "too big too fail," to being "too interconnected to be allowed to fail suddenly." In many cases, a company in a liquidity crisis will file for bankruptcy protection, which automatically stays an action by a creditor to collect a debt or seize collateral from the bankrupt entity. But the Journal reports that Bear Stearns, whose debts are typically secured with collateral, would not have benefited from bank protection due to recent changes in the federal Bankruptcy Code that allow a secured debtor holding collateral to simply liquidate it and seize the proceeds.

Financial Writer Felix Salmon of Seeking Alpha explains how the refusal of other banking firms to trade with a highly leveraged investment bank can cause a liquidity crisis. Bear Stearns had famously refused to participate, alongside its industry peers, in the 1998 bail-out of hedge fund Long Term Capital Management, and as a result, many see Bear Stearns' downfall as retribution.

Early last week, rumors circulated throughout the trading markets that Bear Stearns was experiencing liquidity problems. Such rumors can be a self-fulfilling prophesy if they  produce a devastating “run on the bank,” in which customers withdraw money and other trading firms refuse to trade with the firm rumored to be in trouble. On March 10, Bear Stearns issued a press release stating, “There is absolutely no truth to the rumors of liquidity problems that circulated today in the market.” Alan Schwartz, president and CEO of The Bear Stearns Companies Inc., was quoted as saying, "Bear Stearns' balance sheet, liquidity and capital remain strong."

Yet on the morning of March 14, Wall Street was stunned to learn that Bear Stearns had sought emergency help from the Federal Reserve Board. The Federal Reserve cannot lend money directly to Bear Stearns, which is not a bank. Instead the Fed asked J.P. Morgan to serve as a conduit for an emergency 28-day loan from the Fed to Bear Stearns. The Fed also asked J.P. Morgan to consider providing permanent financing to, or acquiring, Bear Stearns.  The Fed had an interest in saving Bear Stearns because its failure would create direct and collateral damage to the bevy of financial institutions that had trading relationships with Bear Stearns.

The Associated Press presents a timeline of Bear Stearn’s troubles beginning in June 2007.