Bear Rescue Price Shocks Investors

123jump.com Staff
17 Mar, 2008
New York City

Bear Stearns facing bankruptcy and under heavy supervision from the Fed, agreed to a purchase price of $2 per share or $235 million from JP Morgan. The fifth largest broker was essentially liquidated, wiping out the company that only a year ago had a market value of $40 billion. The fire sale price of Bear Stearns sent shock waves around the world. Global markets plunged as investors worried that the U.S. regulators and politicians appear to lack effective tools to stem the recession.

[R]10:30AM New York – U.S. stocks struggle after $2 per share sale of Bear Stearns to JP Morgan sent shock waves in the financial markets around the world.[/R]

On the late evening this Sunday, JP Morgan agreed to acquire Bear Stearns with the Federal Reserve Bank approval for $2 a share or $235 million. The deal what amounts to a fire sale of the fifth largest investment bank to JP Morgan was reached after the Fed urged the directors of the Bear Stearns to have a deal before the end of the weekend to prevent further financial market fallout.

Bear Stearns ((BSC)) stock in the morning traded as low as $2.84, or down 90% after falling 47% in Friday’s trading. Bear Stearns has lost nearly 99% of its market value in the last six weeks.

Bear Stearns suffering from a severe crisis of confidence in the last ten days has been a subject of liquidity stress rumors. On Thursday last week, the bank reached out to the Federal Reserve of New York and was given emergency funding through JP Morgan for 28 days.

The Fed action was a rare step by regulators, and a dramatic expansion of their authority in the last five decades, to prevent the fall of Bear Stearns affecting other financial institutions and potentially that could tangle $600 billion to $800 billion of financial transactions done under the derivative contracts.

JP Morgan was not prepared to engage in the transaction without the guarantee from the Fed and keep itself from engulfed from the widening credit marker crisis. The Fed is facilitating an orderly liquidation of Bear’s portfolio of mortgage securities and has guaranteed to protect JP Morgan from any losses arising from the Bear portfolio liquidation.

Bear Stearns which employed more than 15,000 people worldwide was dangerously leveraged in the mortgage securities trading as most other investment banks are on the Wall Street. The ratio of total financial assets to equity capital of the trading firm was close to 30 to one.

A mere 5% decline in these asset prices could and did wipe out its entire equity capital. Another firm in the UK, controlled by the Carlyle, private equity fund in Washington was forced to liquidate its portfolio of $21 billion after the firm was leveraged to 32 to 1.

Now investors are worried about the potential fallout of similar financial leverages at other investment banks including Merrill Lynch and Lehman Brothers. Merrill Lynch ((MER)) dropped 9% or $3.57 to $39.92 and Lehman ((LEH)) declined $7.66 or 20% to $31.67.

The talks of impending recession in Washington quickly changed its tone and financial regulators and politicians are now worried about the depth and duration of the recession. Henry Paulson in an interview on FOX Business News said that the decision to support a JP Morgan rescue of Bear Stearns was not difficult and had to be viewed from the moral hazard and health of the financial markets perspective. Former Treasury Secretary Robert Rubin last week suggested that the current financial and regulatory tools are not effective to contain the large and interconnected web of risks and obligations that are outside the review of the Federal authorities.

The shareholders and employees of Bear Stearns have taken the biggest hit from the emergency bailout. Joseph Lewis, the billionaire investor operating from the Bahamas, James Cayne, the former chief executive, Ace Greenberg, widely perceived as the person to build the firm, are few of the large stakeholders whose investments have been wiped out. Mr. Lewis is estimated to have lost nearly $1.5 billion of his investment in the firm.

The employees at Bear Stearns are hit the hardest with the fire sale. Most employees in the last three years have received majority of their investments in stock options with a lock up period.

The Bear Stearns’s aggressive reputation in the financial circles has not helped the bank and its employees in the current crisis. Bear Stearns was the lone dissenter during the rescue of hedge fund Long Term Credit Management when the Fed worked with the largest banks and brokerage firms to prevent its collapse.

Markets around the world plunged on the Bear Stearns bailout and deepened the growing conviction that the U.S. regulators and politicians still do not have a handle on the current economic situation. The speed of the Bear Stearns’ demise sent shockwaves in the financial circles in Tokyo, London, and Frankfurt.

In Tokyo Nikkei 225 Index closed lower 454.09 or 3.71% to 11,787.51, in Hong Kong Hang Seng index decreased 1152.50 or 5.18% closed to 21,084.61. Australia ASX 200 index increased 119.90 or 2.30% to close 5,087.00. In Malaysia KL Composite index decreased 17.31 or 1.45% closed to 1,177.53.

In South Korea Kospi Index decreased 25.82 or 1.61% to close at 1,574.44, in Thailand SET index closed lower 11.30 or 1.38% to 806.74 and Indonesia JSE Index edged decreased 71.10 or 2.98% to 2,312.32. Sensex index in India decreased 951.03 or 6.03% to 14,809.49.