The Bear deal

Steve Davidoff analyzes and editorializes on Morgan's purchase of Bear, Stearns.

With respect to the analysis, the bottom line is that, as I said yesterday Bear "might end up getting its cake (Morgan stops the run on the bank) and eating it too (no fire sale to Morgan)." The reason is that Bear shareholders don't have to accept the deal, and may not if conditions improve. There are complications in the agreement, most importantly that the price stands for a year, the board can change its recommendation only there's a higher bid, and Morgan gets an option on the building if the agreement is terminated. But at the end of the year, the shareholders may get their company back at then-prevailing prices. Davidoff suggests that Delaware would not enforce the agreement "in normal time," but I'm not sure what that means, or why not, and anyway these aren't normal times.

As for the editorializing, Davidoff characterizes the deal as the Fed having "bailed out" Morgan with a $30 billion guarantee, with the benefit indicated by the Morgan's next day $12 billion price pop. He then says

it galls me that on Friday, President Bush asserted that we must go slow in helping the millions of struggling American homeowners. He stated that “we got to be careful and mindful that any time the government intervenes in the market, it must do so with clear purpose and great care.” I live in Michigan and drive every day past the many foreclosures and for-sale signs. It breaks my heart that these people are struggling to keep or sell their houses, and the Fed just awarded this boon. Homeowners may not get any meaningful government help, but at least Bear Stearns shareholders will get $2 (perhaps more) a share. Based on James F. Redda & Associates’ share ownership figures, that’s at least $13.4 million to Bear Chairman James Cayne to fund his bridge and golf hobbies.

This reasoning is highly questionable. To be sure, there were private beneficiaries from the Fed guarantee. Bear shareholders may have gained to the extent of $2/share because of the Fed guarantee (plus the value of the implied put back to Morgan). Maybe Morgan can be said to have gained by being in the right place at the right time, with enough liquidity to buy at a fire sale price. Without the Fed guarantee, the Bear shares would have been worthless in a sale or bankruptcy, so Bear might have gone for bankruptcy and avoided the fire sale.

But the public gained as well. Davidoff admits this, saying "I’m not questioning whether market integrity requires this: it appears that it may indeed." The basic problem here is that the public was arguably better off if Bear avoids bankruptcy and the possibly catastrophic disruption in liquidity that may have entailed. At the same time, Bear has a perfect right to seek bankruptcy or not, and its decision depended on whether the government gave it an option. Davidoff discusses the Drexel bankruptcy precedent, noting that that arguably paid off in the end – suggesting it was a viable option here.

In other words, dragging in the homeowners is a pure populist digression. And a costly one at that.  Would ordinary homeowners, or anybody else, really have been better if the Fed had allowed the market to disintegrate?  And I'm not even getting to the question of the extent of "blame" that's appropriate for the homeowners and the Bear shareholders.

And it's worth noting that the price Morgan paid undoubtedly owes more than a little to the need for massive litigation reserves (HT PoL). So if we're looking for beneficiaries of the deal, what about the lawyers?

Comments

[michael webster]

I agree with your comments.

This is possibly the first run on a bank like institution in which the run was created by banking counter parties - who refused to lend because they couldn't value their own liabilities.

I understand the Fed solution to be this:

"We will stop this run by taking over a bank like institution and provide credibility, but the shareholders of the bank will get next to nothing.

If you want to be next in line, keep up your non-trading with other bank like institutions."

Could work; sort of like shooting the first couple of people at the wickets in a bank run - might quiet everyone done a bit.