Holy Cow! This Thing is a Lot Worse than I Thought!!!

From CNN -- subprime mortgages take down Bear Stearns:

JPMorgan Chase & Co. said Sunday that it would acquire troubled Wall Street firm Bear Stearns for a mere fraction of what it was once worth amid deepening fears about further erosion of the world's financial markets.

The all-stock deal values Bear Stearns at $236 million, or just $2 a share. The company's stock had closed at $30 on Friday, down a staggering 47% for the day.

Over the past three days, roughly 200 JPMorgan staffers were working on the deal, assessing the strengths of Bear Stearns' different businesses and its exposure to toxic mortgage securities, JPMorgan executives said during a conference call held Sunday night.

They noted that the offering price, which comes at a steep discount to Bear Stearns book value price of $84 per share, was to provide a cushion to protect JPMorgan in turbulent times and would provide the company "margin for error."

The fire-sale price raises questions about the value of other investment banks.

The danger for JPMorgan will be its potential exposure to lawsuits from Bear Stearns' subprime mortgage division and risks from its derivatives business.

Shares of Bear Stearns opened last week at $69.75 and traded as high as $159 last year, before the firm's bad bets on subprime mortgages blew up two of its hedge funds last summer.

Wow. Who would have believed this even a few days ago. Now the question is -- are other banks in the same spot?

Comments

[MattC]

Another reason to not put all your eggs in one basket - something like 1/3 of all the stock in the company was owned by employees who saw their stock drop over the weekend from the 30's to $2. Not a good weekend!

Of course the deal may not go through - it is subject to the approval of the shareholders. One pointed out that the building itself was worth about $8 per share!

[Tim]

If the building is worth more than the $2 per share value, this is quite ironic right? It sounds similar to many homeowners losing their homes in the subprime mess. I feel bad for the "innocent" employees at Bear Stearns. But the ones who made the decision that put them in this mess ...

[Curtis]

I think it's funny that the main reason most average investors know about Bear Sterns is the fact they've had above average returns for several of the last years. The "darlings of Wall Street." Guess we know why they beat the market. Time to pay the piper.

[AdamCO]

I remember a professor in 2002 or 2003 talking about the value of Nortel stock.

I think this was the analogy (I don't remember the actual prices):
In 2000, you had a choice: either buy Nortel stock or spend the money on a bunch of beer.

The wiser investment? The beer, but only if you recycle. In 2002, the investor would net more money by recycling the empty beer cans than by selling the Nortel stock.

FYI: Nortel was an overvalued tech company from the Nasdaq bust.

So now I'm wondering, buy a house or thousands of cases of beer?

[Mike]

It should probably go without saying that Bear Sterns wasn't a bank. They're an investment firm. Banks aren't failing... yet.

[Kirk]

This is going to get worse. Lehman is in question now. I am sure more are to come. I just hope the Fed, and the taxpayers, don't end up bailing all of these organizations out. Bear Stearns was a particularly nasty player in the finance world. They refused to help any other organizations; they played real hardball. Yet, once they found trouble, the Fed rushed to the rescue.

I just hope we aren't heading for a Japan like slump. I feel like we are though. Japan refused to let big banks fail. The government propped them up artificially with taxpayer money. And, the Japanese central bank lowered rates to zero. This made the yen practically worthless which has hampered their economy for a decade. Our Fed is following the same playbook.

[JACK]

Kirk is right. We should be quite fearful of these Fed bailouts. Make no mistake about it -- some companies should fail because of this subprime crisis. To bail them out with taxpayer money is idiotic. But the government still believes that Mr. Keynes is right and so we are going to play that dumb game. And it will cost the rest of us.

[Sarah]

I just hope people remember all this the next time we start hearing about how the government shouldn't regulate those super-smart guys in finance, it just gets in the way of the free market, which is good for everyone HUZZAH!

Regulate now or bail out at god knows what markup later, folks.

[Lily]

Kirk: "Bear Stearns ... refused to help any other organizations."

By which you mean Bear refused to prop up Long-Term Capital Management as it was crumbling? Sounds like you're saying that the bail-out would be more justifiable had Bear been "friendly," or that Bear's demise is more satisfying because it had played "hardball." Wake up: investment banks are there to make money for themselves and for shareholders. They're not there to be nice. The fact that Bear wouldn't help out LTCM or wouldn't play nice should have no bearing on whether its demise is deserved or not.

Sarah: "Regulate now or bail out at god knows what markup later, folks."

You're saying that the government should regulate banking more. But would this really have prevented the credit crisis? Where will the government get the resources to double-check Wall Street's numbers? The likely scenario, had the government been involved at the budding mortgage crisis, is that the government would have deferred to the credit rating agencies (S&P, Moody's, Fitch) - like everyone else did - and misjudged the credit market - like everyone else did.

This isn't to say that I'm against government regulations. I'm just doubtful that they can be implemented correctly and effectively.

At any rate, if you're against the bail-out, then you're really pro-free-market after all. Otherwise, you're really advocating selective government intervention (regulate, and when things go wrong, say, "I didn't do it!").

[Jake]

Yes, very important to note that BSC (and LEH) are not banks. That's why they are more vulnerable. They are smaller and less regulated and more leveraged than banks.

[Zook]

If you bought BSC on Thursday of last week at $57.00, you are down to $3.75 today.

Lesson here is to buy indexes and maintain and nice, comfortable asset allocation.

Great points Jake and it should be noted in BOLD AND IN CAPS. These are investment banks on a much larger scale. It is a big deal, but they leveraged themselves to their own death.

[observer]

> Who would have believed this even a few days ago.

Not to be a jerk but some people have been predicting this for the last year. The only reason I'm following your blog is to observe how you folks react to the unraveling of the US financial system.

> Our Fed is following the same playbook.

Of course they are. You don't think they care about how their actions affect you, do you?

> Otherwise, you're really advocating selective government intervention

Of course, all intervention/regulation is selective. Deregulation of various industries in the US has always been followed by higher prices to consumers and defrauding taxpayers (telecom, energy, banking, etc). I wish that was not the case but I refuse to ignore history just to promote an ideology. Ultimately the government has to act as a check on the actions of businesses in order prevent periods of economic turmoil like the one the US has entered.

[FMF]

>Some people have been predicting this for the last year.

"Some" people have been predicting almost anything you'd like to hear. If you listen to all of them, you'll do nothing but chase your tail.

>How you folks react to the unraveling of the US financial system.

Ha! I'd hardly call this unraveling.

[Ryan S]

FMF,

Agreed, if anyone truly believes that the US financial system is unraveling, in reality they would be moving to Argentina or some other 3rd world country before it happens.

[indio]

This blog has had an interesting and somewhat prescient analysis over the past few weeks. http://blog.greenwichfinancial.com/2008/03/fed-acted-of-necessity.html

I'm not packing my bags, though a vacation would be nice, just keeping most of my resources in cash.

[Sarah]

"Wake up: investment banks are there to make money for themselves and for shareholders. They're not there to be nice."

Which is exactly why we need to keep an eagle eye on them, rather than deferring to them and letting them cook up whatever ridiculous debt-leveraging pyramid schemes they can come up with to line their own pockets before it all comes crashing down at our expense. The idea that letting rapacious bastards take the market for all it's worth will somehow magically work out to all our benefits couldn't be more exposed as a fantasy than it is today. This crisis happened because mortage lending is underregulated, the credit-rating agencies are in bed with the securities issuers (it's not just an accident or coincidence that the garbage CDOs had AA ratings to start with), and no one is even trying to make investment banks value their instruments realistically.

(As for making money for their shareholders: HAHAHAHAAHAHAHAHAHAHAH. The offer Bear agreed to wouldn't make a share worth a cup of coffee in Manhattan. If there aren't half a dozen plaintiffs' firms champing at the bit to file suits as soon as the deal is finalized, I'll eat my hat. Which is a nice attractive fedora I'd hate to lose. James Cayne & co. will land on their feet. The shareholders? Good luck!)