JP Morgan, Fed Move To Bail Out Bear Stearns
Kurt Brouwer March 14th, 2008
It appears that Bear Stearns’ attempts to stem the tide of capital fleeing the venerable investment bank may have failed. As in other recents cases such as Thornburg Mortgage, this appears to be driven more by liquidity needs than anything else. The investment bank apparently borrowed short-term and invested or lent over the long-term.
Now, its creditors are calling in their loans and the company is scrambling to find other sources of capital. JP Morgan apparently is stepping in with guarantees of some sort from the Feds [emphasis added below]:
JP Morgan, Fed Move To Bail Out Bear Stearns (New York Times, March 14, 2008, Landon Thomas Jr.)
Bear Stearns, facing a grave liquidity crisis, reached out to JPMorgan on Friday for a short-term financial lifeline and now faces the prospect of the end of its 85-year run as an independent investment bank.
With the support of the Federal Reserve Bank of New York, JPMorgan said in a statement that it had “agreed to provide secured funding to Bear Stearns, as necessary, for an initial period of up to 28 days.”
For the next month, JPMorgan will work with Bear Stearns to reach a solution for its financing crisis. Options could include organizing permanent financing or, according to people briefed on the discussions, buying the bank for a discounted price.
“JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company,” JPMorgan said in its statement.
This is not the outcome Bear Stearns shareholders would seek, but it is an example of the creative destruction of capitalism (see Paul Krugman — Capitalism’s Mysterious Triumph). Though they are different types of companies, this type of lack of liquidity led to the sale of Countrywide Mortgage (see Bank of America Snaps Up Countrywide) and no doubt it will happen again.
The rescue plan represents a devastating if not ultimately final blow for Bear Stearns, a scrappy and until now resilient investment bank that carved out a niche for itself by mastering the intricacies of the United States mortgage market.
But after two of its hedge funds that specialized in the subprime mortgage market collapsed last summer, Bear’s expertise became its Achilles’ heel as the plummeting market for complex securities tied to subprime mortgages severely damaged its core business. [For more on Bear Stearns hedge fund problems, see Bear Stearns — $3.2 Billion Hedge Fund Bailout].
In recent days, Bear’s stock has plummeted more than 20 percent as investors as well as clients and broker dealers have shied away from the firm, fearing that their continued exposure to plunging real estate assets threatened their solvency.
The announcement on Friday did little to prevent wholesale selling in the firm’s stock, which was down more than 35 percent, to $36.53 a share, at 1 p.m., after falling as low as $26.85, its lowest level in nearly a decade.
On Wednesday, Bear’s chief executive, Alan Schwartz, said in an interview on CNBC that his firm had ample liquidity, but his words have not been enough to prevent what seem to be a classic run on the bank…”
This is a classic run on the bank. If you invest or lend borrowed capital, ultimately you are vulnerable to creditors who lose confidence in your management.
The lack of confidence shows in the precipitous decline in the company’s share price and the burgeoning activity in Bear Stearns put options. I suspect JP Morgan or another institution will take it over.
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