Bear: Did the Fed and Treasury Push Too Hard?

Andrew Ross Sorkin in the New York Times provides some important background on how the Bear deal wound up being retraded today. But he does his readers and the greater public a huge disservice by telling the story so as to flatter Wall Street.

According to Sorkin, the $2 price for Bear was the Fed’s and Treasury’s idea; JP Morgan was prepared to pay more, but they nixed the idea, saying they did not like the “optics” of the deal. The implication is that the officials overstepped their bounds. That is a pretty outrageous spin when the government is putting up taxpayer money.

Had it been an option, the Fed should have nationalized Bear. It was going to declare bankruptcy Monday if there was no deal; its shareholders would have been wiped out. Why am I so confident of this view? If bondholders, as rumored, were buying shares to make sure the JPM deal went through (and thus would take losses on their stock purchases when the deal closed), that meant that they thought their bonds were worth well under 100 cents on the dollar in a bankruptcy. Shareholders are subordinate to bondholders, so equity owners would have gotten zilch.

I can think of a host of reasons, however, why the Fed did not go the nationalization route, the biggest being that it lacked clear authority (it couldn’t declare Bear to be insolvent, as it could a member bank). And letting Bear fail (and having acsounts frozen) was what the Fed was trying to avoid, so letting it fail and then seizing control (even assuming it could do that) was never an option. No doubt, the central bank also did not want to assume administrative control of an entity that it had never regulated (ie, its supervisors had never kicked its tires) that dealt actively in markets in which the Fed has little expertise. Even in an orderly liquidation scenario, that it a lot to take on.

Sorkin nevertheless argues that the Fed did Bear a dirty because:

…..the night that Bear signed the original bid, the Fed opened what’s known as the discount window to companies like Goldman Sachs and Lehman Brothers — oh, yes, and to Bear, too. Except that the Fed didn’t tell Bear that it planned to open the window when it was signing its deal with JPMorgan.

This verges on being revisionist history. First and most important, the discount window was opened to keep the panic about Bear from spreading to other firms, most notably Lehman. It almost certainly would not have happened then if Bear was not on the verge of imploding. Remember, a mere week and a day ago, there was pervasive fear that the wheels were about to come off the financial system, particularly if counterparties started getting leery of dealing with Lehman.

Moreover, usage of the new discount window the first week was light due to worries about stigma. If Bear had gone and used it aggressively, it may well have reinforced rather than allayed fears about the trading firm’s health. If other firms continued to refuse to deal with Bear, its collapse was assured. There was a very real possibility that even if Bear had remained independent and used the window, its bankruptcy merely would have been delayed a day or two. And it would have been well nigh impossible to put together a three party takeover deal between the close of business in New York and market opening in Asia on a weekday.

But the most appalling aspect of Sorkin’s account: he acts as if Bear had the right to be informed of the Fed’s plans. Sorkin seems to have forgotten the golden rule: he who has the gold makes the rules. The Fed had every right to be calling the shots. They were taking the biggest risk in this transaction. The notion that a firm about to fail is entitled to be treated as a being on an equal footing with its rescuers is absurd. And the fact that Sorkin (and presumably others on Wall Street) sympathize with this view says the industry badly needs to be leashed and collared.

Finally, a series of posts at Dealbreaker suggest that JPM knew full well that it was guaranteeing Bear’s trades (the supposed mistake in the contract):

As we pointed out this morning, we don’t think it was an oversight. On the conference call on the Sunday night the deal was announced there was a lot of discussion of the guarantee. Some of it was confusing, as much of what happens on public conference calls is often confusing. But it seems pretty clear that JP Morgan fully understood that it’s guarantee would cover Bear liabilities even if the deal was rejected.

After the jump, we present an excerpt from the transcript of the Sunday night conference call. In the excerpt, Steve Black, the co-head of JP Morgan’s investment banking division, is asked by an analyst about the guarantee. He clearly says that it will cover Bear liabilities already entered into and those entered into prior to closing or rejection, but not those entered into after the rejection.

Sorkin also makes clear that Dimon was unhappy paying so little for Bear and was concerned about a revolt among those employees he wanted to keep. That then raises the question of whether the supposed fits thrown by Dimon over the trading guarantees really were a bad case of buyer’s regret. After all, at a price of $2, JPM was paying more than a billion less than than it eventually offered. Was that exposure really so awful that the economic value of getting out of it was worth a billion plus?

It thus seems more plausible that the alleged contract defects gave Dimon the excuse to pay the price he wanted to pay to keep peace in the family. And I will go further: knowing a bit about one of the attorneys involved (Rodgin Cohen of Sullivan & Cromwell, who represented Bear), I consider it quite possible that the lawyers contrived to have glitches in the deal to allow it to be reopened. (On a deal I was involved in, Cohen pulled a huge ruse with the Fed that my client to this day is unaware of, according to Gene Ludwig, who was later my attorney). Their loyalties are to the Street, not the Fed or the public at large.

Even the Times’ news reporting (a story by Lanodn Thomas and Eric Dash) falls for the Wall Street party line:

Mr. Dimon’s about-face illustrates the deep complexity and political sensitivity of a deal with participants who reached into the highest corners of Washington, from the Treasury to the Federal Reserve System. It also underscores the extent to which JPMorgan and government officials underestimated the wave of anger and opposition that would flow from irate Bear employees and shareholders who saw the original $236 million that JPMorgan agreed to pay just a week earlier as far too cheap….

And finally, the low-ball offer cast Mr. Dimon as an unscrupulous negotiator in the eyes of envious rivals, who felt no compunction in raiding Bear for its talent, with many employees only too happy to leave. The new terms, he hopes, will show him to be a more pragmatic deal maker, willing to seek compromise to save a deal that for the time being at least, brought a jolt of confidence to Wall Street.

Bear was going to fail as of Monday. Bye bye equity and many if not most jobs. How hard is this to understand? I thought anyone who was remotely financially literate understood what bankruptcy means. The employees should be grateful to get anything. But no, the media slavishly accepts their sense of entitlement.

So I don’t buy Sorkin’s theory that the Fed overreached. In fact, I’m deeply offended that he is presenting this idea at all. It’s part of the conspiracy to foist the losses of a reckless securities industry onto the public at large.

Update 1:40 AM: A post by Steve Davidoff at the New York Times’ Dealbook argues that the revised deal could be more susceptible to being upended by the Delaware courts. While most Bear shareholders have reportedly thrown in the towel, billionaire Joe Lewis has the funds and motivation to keep fighting.

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  1. vlade

    One thing noone commented on was that it was clear JPM would raise from the amount they put aside for litigation (6bn).
    If a whole bear costs 250m at 2 a pop, 6b puts the price at 48, so even at 10 it’s still a bargain.
    Of course, money aside for litigation are soft money, but so are money paid – i.e. JPM’s shares.

  2. Lune

    I find Wall St. reporting increasingly resembling People Weekly or US Magazine. The most significant change in Fed policy since the Great Depression, likely to have ramifications for monetary and regulatory policy for decades hence, and all the so-called “financial” reporters are reduced to high school gossip about who got to sit at which lunch table, why Lisa told Jen about Johnny but didn’t tell Rachel and OMG that was, like, so harsh!

    Give me a break! Why is it that for actual analysis of the financial or economic implications of the day’s news, we have to go to overseas publications like FT, while our own papers like WSJ and NYT spend their column inches on “inside gossip” and “exclusive rumors”?

    To the extent that sometimes the personal side can illuminate the driving forces and motivations behind policy, it can be useful. But I suspect much of this reporting is a showing off to other reporters about who has access to what sources and how close to the “inside” you can get. Sort of like who gets invited to the cool kids’ lunch table in high school.

  3. TallIndian

    The NYT article seems to ignore the fact that the discount window as ‘de facto’ opened to BSC via its clearing bank, JPM. But then what do you expect from the newspaper of Whitewater, Wen Ho Lee and Judith Miller?

    More importantly, the FED action signals a major shift in that government bailouts now extend to bond holders. All prior ‘nationalizations’ (Continential Illinois, the S&Ls in the ’80s and ’90s) involved sending shareholder equity to 0 and reducing bond holders close to 0 while protecting all depositors.

    Now, our government will bend any rule, spare no expense, to protect bond holders (and derivative counterparties) of banks and selected broker dealers.

    Financial institution debt is now apparently parri passu with U. S. Treasury debt.

  4. Anonymous

    Andrew Ross Sorkin is merely doing what too many journalists do: echoing the meta-narrative of our times. Government is a morally bad actor. Free markets are the single answer to all problems — even the problems created by free markets. Don’t look for internal consistency in this narrative. There is none. Look instead for the meta-themes. Look for the bitch slap — for the Fed cannot stand by and let our free market system fail but the Fed needs to take complete direction from the free market system and any deviation from taking complete direction from the free market is just one more lamentable example of government interfering with the free market.

    Don’t you get it?

  5. Anonymous

    But it seems pretty clear that JP Morgan fully understood that it’s guarantee…

    Nitpicking maybe, but…

    It’s amazing how often you see mistaken use of it’s and its, even among people who really ought to know better, and in published material that really ought to be proofread several times.

  6. Anantha

    you are right to detect a note of sympathy running through the media commentary on Bear Stearns. I guess the rationale could be that the journalists feel that Bear was unfairly beaten to death (almost) by speculators and perhaps fellow institutions. Implicit in this is the belief that no big American financial institution can really fold up now. That betrays a mindset of denial about the problems.

  7. Yves Smith

    Anon of 8:15 AM,

    I do “understand” the proper usage of its and it’s.I have repeatedly told readers I am bad at typos. That is one reason I left the securities industry. They place a premium on that skill.

    It is rather offensive that you decide to attack me over this. Other readers try to be helpful in pointing out typos. And if you had ever published an article, you would know that journalists and writers, unlike bloggers, have everything edited by a line editor (there is often a separate editor for content/style, which shows how specialized a skill this is). They don’t have to worry about typos when they are trying to meet deadlines.

    I also, and have said before, that I am not good at proofreading, A reader told me last night I had typed the date in incorrect. He didn’t presume that I was unable to use a calendar.

    I have in fact been tested as not being good at typos, and that was before the days of spell check (and I also know how to spell quite well), I have terrible manual dexterity and type slowly as well.

    Now, do you just want me to quit posting? Most of what I write is news driven. I think it is more important to my readers to be timely than write 15% less or be considerably later by virtue of being meticulous. Or you if it bothers you that much, you can pay for a line editor.

  8. Yves Smith

    Anon of 8:15 AM,

    Oh, and now that I look at the post, the incorrect usage of “it’s” came in a quote (which I assure you was cut and pasted) from Dealbreaker, which (unlike me) is a real organization with multiple writers and a large number of display ads, But no, you accuse me of paying insufficient attention, yet you didn’t bother to read the post closely before criticizing me.

  9. Anonymous

    How happy are Bear bondholders? Two weeks ago they held paper trading for 70 cents on the dollar. One week ago, the JP Morgan Chase takeover rocketed it back to par. Then they were reported to be heavy buyers of Bear stock at $4-5 a share, so as to be able to vote FOR the deal and against the revolt of Lewis and the Bear employees. Now, voila`, their stock is worth double. Ain’t America great?

  10. sk

    I have sympathy for BSC ( no shorts or longs in the stock ) shareholders because of the way the discount window was opened for primary dealers just after their sale, under threat of imminent bankruptcy, to JPM was done, under the auspices of the Fed and Treasury.

    I know some say that it was to prevent problems to other primary dealers, problems caused to them BY BSC’s problems – but if the window had been open to BSC maybe BSC’s problem would have liquidated away and there would have been no problems for other primary dealers.

    Its all speculation – but to me it looks like they wanted to make an example of BSC – and THEN put, what they see as a fix to the liquidity of primary dealers, in place.

    Its playing favorites IMO – so much for wanting to protecting the system.

  11. Lune


    While I’m sure BSC people feel slighted, they’re way off base for two reasons.

    Firstly, the Fed didn’t have it in for them. They were just the first IB to fail, and thus forced Fed action. The Fed did their best to put in place a guarantee ASAP (the main reason they went to JPM was because it was logistically easier to go through a regulated bank than spend a few days figuring out how to bail out BSC directly). If Lehman had failed before BSC, then they’d be the one facing BK, while BSC would have been saved. If BSC feels they were wronged, they should ask themselves why they were so incompetent that their IB went belly up first while others managed to hold on. That’s the real reason for their current predicament.

    Secondly, BSC shareholders should be thankful that they’re getting $10/share. If it wasn’t for the Fed, they wouldn’t even get that. I’m still of the opinion that the Fed should have done nothing and let them go all the way to bankruptcy (even if that means Lehman and others would have quickly followed suit). BSC’s problems have been known since last summer. Their stock price had already fallen significantly by the beginning of this year. If you still had BSC stock, you weren’t some poor investor just trying to park your 401k in a safe company with no clue about the underlying turmoil in the company. You were a vulture investor speculating on distressed equity for a big payout. Such speculators should be thanking their heavens they’re getting $10/share instead of the $0 that is their rightful due.

  12. Anonymous

    I’m with that other anonymous douche bag — the real problem here is one of punctuation. I bet if you’d just bother to proof read your posts BSC would still be trading north of $60.

  13. Genesis

    Bear would not have failed Monday if they had access to the Discount Window.

    The vote to open the window to IBs was taken before the deal was made for Bear.

    The Fed’s active involvement in this transaction without disclosing this material piece of information (that would have instantaneously blown the deal up) is outrageous.

    In effect The Fed has stolen $30 billion (now $29 billion) from the US Citizens and locked it up in an LLC – an “off balance sheet vehicle” just like Enron used – after conjuring the failure of Bear.

    Yes, Bear was going to go down Monday. But so was Lehman, and by opening the Window, they stopped that.

    Further, The Fed’s actions were and are clearly outside of their authority as delegated by The Federal Reserve Act of 1913.

    This crap has to be stopped kids. IF we contaminate our Treasury Bill repository (the largest piece of which, in the US, resides in The Fed) we run the risk of provoking capital flight and a collapse in our currency – and ultimately our economy.

    All spending bills must originate in The House, by our Constitution. The Fed has no authority to “spend” $29 billion of our money without an explicit allocation by Congress. Period.

    This demands investigation and, if the facts are as they appear, impeachment.

    Yes, I said impeachment, as The Executive was clearly (by their own admission) involved.

    Petition To Fix This and The Blog where this is all outlined

  14. Anonymous

    If the Fed is willing to lend $29 billion for 10+ years, collateralized by assets owned by Bear Stearns, why involve JP Morgan Chase at all?

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