03/18/08
The Bear Stearns debacle
I'm taking a break from political writing for a moment as I decompress from the incredible day in the market on Monday. Even though we've seen bigger moves with some frequency in recent months, there was something about Monday which was truly frightening.
I've been trading a little bit of Bear, Stearns (BSC) which was 55 on Thursday, 30 on Friday, and under $5 now, after it agreed to be taken over at $2/share by J.P. Morgan Chase (with their alternative apparently being bankruptcy.)
I don't talk much trading here, but I have to mention how interesting it is (and, in my view a trading opportunity) that April calls in BSC are trading so high. Bear has agreed to the $2 price. It's unlikely that any other buyer could get permission from the Fed to intervene. It's unlikely that there are any interested buyers who have the financial strength to complete the deal. J.P. Morgan apparently got an option on the Bear, Stearns building in Manhattan which they would likely use if somehow the deal fell apart.
In other words, I just don't see how this deal gets broken up or the price gets changed. [Update: The WSJ makes a convincing case that simply the fact of BSC stock trading so far above the deal price may put enough pressure on JP Morgan that they may have to sweeten the deal, so my certainty about the $2 price looks like it may be wrong...]
But still there is so much anger out there from big BSC shareholders that some people seem to think JPM will be forced to pay a little more. And clearly the market thought JPM got a bargain, since the stock was up nearly $4/share on the news. (And traded over $7 for a time on Tuesday.)
But JPM has all the leverage (pun intended), and as BSC employees leave in droves over coming days, the enterprise value of Bear, Stearns will drop rapidly, especially in the trading area.
So I think BSC calls are a sale, especially on strikes over $15...I just don't see that high a price happening. [Note: I mean particularly in first and second-month options.]
I am not telling any of you what to trade...and if you trade anything based on any of this I accept no responsibility! I am already short BSC calls.
Trading opportunities like this are rare, but not as rare as they used to be in this time of tremendous market turmoil, especially in financial and commodity stocks.
And, it "bears" mentioning: What a sad story this is. So many BSC employees had taken a lot of salary in stock...money they were counting on for their retirements, their kids' colleges, etc. And unlike the perception of many who aren't in the financial industry, the vast majority of employees in investment banks are not hotshot traders who make millions of dollars a year. Most are just people with jobs, some good jobs, some not so great jobs, just like any other company. The difference is that investment banks tend to have more employees owning stock, and in larger quantities as a share of their total income or net worth, than in other businesses. And there is often a political stigma against selling the stock. These people are stuck...and financially ruined...much like people in Enron. This story is sadder than Enron, in my opinion, because there is no obvious fraud here. It was simply a run on a bank that hadn't prepared properly and had no choice but to sell out to the only available buyer at the only available price.
I hope this doesn't happen to any other of the large firms. There is absolutely nothing good about this story except for the few people who are shareholders of JPM. And, once again, Jamie Dimon has proven that he is the greatest banker in the world. He deserves true congratulations for getting this done, but I wish he had never had the opportunity.
In response to Bob's comment from yesterday about this being a "back-room" deal, and his question about the plunge in the stock price.
In a sense, Bob, the latter disproves the former in the sense of any sort of sweetheart deal for Bear shareholders.
Bear is being (ruthlessly) punished for management which remained over-leveraged in an environment which was taking no prisoners when it came to deleveraging.
As far as JP Morgan shareholders, they are being rewarded for some of the only management on Wall Street which basically avoided the mortgage and credit/leverage disaster we're going through right now.
One can argue that JPM got a good deal at $2/share for BSC, but there's a strong case to be made that the stock should be worthless. Furthermore, without JPM buying Bear, Bear wouldn't have been able to open its doors today, which would have lead to a massive collapse in financial markets and the banking system.
To the extent that it was a back-room deal, it's because you only need one room when there is only one possible buyer for a company that has no choice but to sell.
I suggest you read John Mauldin's piece on this subject:
http://www.investorsinsight.com/otb_va.aspx?EditionID=667
This is absolutely not an example of an economy being managed by a central authority. The Fed jumped in with some guarantees in order to facilitate the orderly takeover of Bear, Stearns rather than watch it collapse and take much of the American financial system down with it.
2 comments
on 03/18/08 at 10:28
I think that there is fraud here on two insidious levels and I think Bear is only one of the many perpetrators.
The first way in which there is fraud is in the use of poorly understood and esoteric derivatives products to mask risk. (I'm not against derivatives at all, only their misuse)As long as the profits are rolling in no one bothers to peek at the true source of those profits and determine the real risk characteristics and profile of the instruments positions. Or to see if the risk/return is even properly compensatory, something truly grasped by too few.
Much like the LTC debacle, much of what Bear and others have been doing has been veiled in false notions of 'cross hedging' which in many cases is no real hedge at all but merely a temporary relationship between various instruments that has the appearance of a hedge. Every time apples go up oranges go down.... No one ever asks what happens if all fruit prices go up or down simultaneously and so the risk monitors never take that possibility into account and proper margins, reserve funding and position size as relates to global portfolio exposure is never questioned or maintained.
It always seems to be just another contrived way of over-booking the longshot and then it's always a BIG surprise when it comes in and the house of cards collapses. (excuse the mixed metaphors)
The second and even more insidious fraud lies in who ultimately pays the price for these failed practices. No "genius" trader is ever required to return the years of profits and bonuses he has received for betting other people's money. He, in most cases, receives a far larger compensation than the people who unknowingly are backing his trades. They are in fact not being adequately compensated for the risk they are being exposed to. This sort of cynicism goes even further when there is an implicit thought that if the shit ever does hit the fan Bear and companies like it will be bailed out partially or in total by taxpayer dollars because the aftermath of collapse is too far reaching for the rest of the economy.
I'm sure you remember the variations of this theme which we used to joke about back in the heyday of index trading. We called it the Paraguay spread or some such thing. Basically the idea was you had a plane ticket to Paraguay (or Hong Kong in one famous case) in your pocket and you sold the hell out of "worthless" puts. If nothing happened you cash in, if all hell broke lose you simply board the plane....
I'm no fan of over-regulation but how many times are we going to see this play out, in how many ways before someone takes the step of not allowing contrived derivatives to be used as way of masking true risk and forcing firms to value their risk properly such that they are not 'free rolling' everyone else?
That, and the recent concerns about liquidity problems driving inflationary behaviour (a 0.75% cut? Give me a break!) leads me to believe the Fed is being too influenced by politics.
Let the recession come, damn it. The economy needs it to restart. Fed's just prolonging the agony, putting a huge burden on tax payers and punishing consumers (The € is at $1.5....who soon will that raise to $1.6 or even 1.7 on these dropping rates?)
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