Bear Stearns Cos., teetering on the brink of collapse from a lack of cash, got emergency funding from the Federal Reserve and JPMorgan Chase & Co. in the largest government bailout of a U.S. securities firm.
After denying earlier this week that access to capital was at risk, Bear Stearns Chief Executive Officer Alan Schwartz said today that the 85-year-old company's cash position had "significantly deteriorated" in the past 24 hours. The central bank agreed to provide financing through JPMorgan for up to 28 days, the bank said in a statement today.
JPMorgan, led by Chief Executive Officer Jamie Dimon, is considering buying Bear Stearns, among other options, according to three people briefed on the matter. No agreement has been reached and it's possible that no deal will be completed, said the people, who declined be identified because the discussions are confidential. A person close to JPMorgan said the bank may also be interested in buying Bear Stearns's prime brokerage unit, which provides loans and processes trades for hedge funds.
The Fed acted to prevent the failure of the second-biggest underwriter of U.S. mortgage bonds and forestall a potential market panic as losses by banks and brokers reached $195 billion and stocks plunged for a third day this week. JPMorgan, which has suffered fewer losses than rivals during the credit crisis, may end up owning all or part of Bear Stearns, analysts speculated.
`Market Rumors'
"I don't think they can afford to let Bear go," said Charles Geisst, the author of "100 Years on Wall Street," referring to the New York Fed bailout. "At this particular moment in time, it would be a devastating blow to the markets."
Bear Stearns, founded in 1923, acted in response to "market rumors" of a liquidity crisis, CEO Schwartz, 57, said in a separate statement. He said earlier this week that the company's "liquidity cushion" was sufficient to weather the credit-market contraction. Traders have been reluctant to engage in long-term transactions with Bear Stearns as the counterparty, the Wall Street Journal reported yesterday.
"We have tried to confront and dispel these rumors and parse fact from fiction," Schwartz, who was named CEO less than three months ago, said in the New York-based company's statement today. "Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated."
The announcement caused financial shares to plunge, with Bear Stearns tumbling a record 47 percent to $30 at 4 p.m. in New York Stock Exchange composite trading. The stock has lost 66 percent of its value this year.
Hedge Fund Failure
Lehman Brothers Holdings Inc., Citigroup Inc. and Bank of America Corp. also led declines as all 10 industry groups in the Standard & Poor's 500 Index fell. Lehman, the biggest underwriter of U.S. mortgage bonds, said it obtained a $2 billion, three-year credit line from 40 banks.
Bear Stearns's long-term counterparty credit rating was reduced three levels to BBB by Standard & Poor's. The rating may be cut further, New York-based S&P said. It lowered the short- term rating to A3 from A1. Moody's Investors Service also downgraded the company's long-term rating to Baa1 from A2.
Bear Stearns, which first sold shares to the public in 1985, helped trigger a crash in the market for home loans to borrowers with blemished credit histories after two of its hedge funds collapsed in July. The failure of the two funds, which invested in securities linked to subprime mortgages, prompted a sell-off of the assets, which in turn led investors to shun other high-yield debt.
Cayne's Pick
Schwartz, an executive with more than 30 years of experience at Bear Stearns, was the hand-picked choice of his predecessor, James "Jimmy" Cayne, 74, who remains non- executive chairman of the firm. Cayne stepped down after reporting an $854 million fourth-quarter loss, the first in the company's history.
On a conference call with analysts and investors after today's announcement, Schwartz said the company's book value was "fundamentally" unchanged. Clients have continued to withdraw funds today, he said.
The firm has retained investment bank Lazard Ltd. to seek "strategic alternatives," Schwartz said. Bear Stearns said it's also in talks with New York-based JPMorgan about long-term funding.
Steven Black, JPMorgan's co-head of investment banking, said on Feb. 27 that the bank was considering acquiring a prime brokerage that was for sale then. He didn't name the seller. Bank of America, based in Charlotte, North Carolina, said on Jan. 15 that it planned to sell its prime brokerage.
For Sale
"There happens to be one for sale and we are looking at it," Black said at a JPMorgan investor conference in New York.
The Bear Stearns bailout was announced hours before President George W. Bush delivered a speech on the U.S. economic outlook.
"Our economy obviously is going through a tough time," Bush said to business and finance leaders at the Economic Club of New York. "In the long run, I'm confident our economy will continue to grow because the foundation is solid."
Bear Stearns led Wall Street shares lower this year as the world's largest lenders and securities firms wrote down assets linked to the subprime mortgage market. Analysts in the past month have lowered expectations for earnings in the first quarter. JPMorgan has posted $3.7 billion in writedowns, a fraction of the $22.4 billion reported by Citigroup, the biggest U.S. bank by assets.
Good Pockets
"JPMorgan is not loaded up with bad mortgage debt," said Vincent Farrell, principal at Scotsman Capital Management. "Bear has a couple of very good pockets that any other firm would want to have if you can clear up the balance-sheet issue."
About a sixth of the firm's income came from packaging and trading mortgage bonds, a market that has been almost completely frozen since July.
"The future for Bear will be found in a forced marriage," said Charles Peabody, an analyst at Portales Partners LLC in New York who rates the stock a "sell." "Their business model is broken. They don't have the ability to go it alone."
Joseph Lewis, the second-largest shareholder in Bear Stearns Cos., wasn't planning to reduce his stake, a person close to him said March 11. Lewis, a 71-year-old billionaire, views his 9.4 percent investment as long-term, the person said.
The Fed is taking on the credit risk from collateral supplied by Bear Stearns, which approached the central bank for emergency funds, Fed staff officials said today.
Bernanke's Vote
The Fed, under Chairman Ben S. Bernanke, voted unanimously to lend the funds through JPMorgan because it would be operationally simpler than a direct loan to Bear Stearns, the staff said on condition of anonymity. The regulator invoked a little-used law that allows it to make loans to corporations and private partnerships, which required a Board vote, according to the staffers.
The Fed said it was "monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system."
The senior staffers declined to describe how large the loan to Bear Stearns was, and declined to say whether a private- sector bailout was attempted before the Fed extended credit through JPMorgan.
"The issue now is whether Bear Stearns customers will stick around," said Bruce Foerster, president of South Beach Capital Markets and a former Wall Street executive. "Some others have gotten through the same kind of troubles, some ended up being shut down or sold. I'm hoping Bear can get past it."
JPMorgan's Feather
JPMorgan's participation in the bailout follows a long tradition at the bank of stepping in to rescue financial markets from crisis, according to Geisst, the Wall Street historian.
The bank has also profited from others' crises. JPMorgan got at least $725 million of revenue for taking on half the energy trades from collapsed hedge fund Amaranth Advisors LLC in 2006.
"It may be a feather in JPMorgan's cap that they're considered able to do this," Geisst said. "The Fed could have chosen any number of banks to do this, and they chose JPMorgan."
source: 15mar2008
Behind the swift decline of Bear Stearns Cos. is a deepening worry on Wall Street that some financial institutions might not be able to make good on their commitments.
Such angst about the health of an institution holding somebody else's money is an age-old worry in finance. The federal government created the Federal Deposit Insurance Corp. in 1933 to give bank depositors confidence they would never again face such concerns.
Wall Street's modern version of what is known as "counterparty risk" has taken on a highly complex face. An explosion of derivatives instruments has potentially bound financial institutions with each other in ways and magnitudes they might not yet fully understand. And it has made confidence in the system — now fraying — especially important.
Bear had denied rumors of financial stress for days, but Friday said persistent rumors about its financial health had caused some lenders and clients to back away from financing or trading with the firm and forced it to turn to J.P. Morgan Chase & Co. for help.
Some hedge-fund clients had demanded that Bear come up with cash as collateral on trades they had done with the firm or had withdrawn funds from their accounts with the firm, further straining its finances. Taken together, it was like a modern version of a bank run.
One example was Renaissance Technologies Corp., the hedge fund run by James Simons. It shifted its assets away from Bear Stearns in the past week, according to people close to the matter. In the case of Renaissance, which oversees more than $30 billion, the hit on Bear was big because the transfer involved several billion dollars of assets into the hands of Wall Street rivals, the people said.
Debt investors said Bear's problems underscored the fragility of the financial markets and the vulnerability faced by broker-dealers to changes in market perceptions. While commercial banks can fall back on stable customer deposits for cash, investment banks rely on the faith of financial markets.
"The nature of financial companies is that they are pretty much a black box," said Jeff Houston, a bond-fund manager at American Century Investments in San Francisco. "If people start to worry about what's in the box, there's not much the firms can do to demonstrate that they are not as weak as they appear to be."
In the past few months, the market's concerns about counterparty failures mainly centered on the solvency of bond insurers that sold credit protection on complex mortgage securities to banks and brokerages. Those concerns subsided a little when bond insurers MBIA Inc. and Ambac Financial Group Inc. raised capital to protect their top financial strength ratings.
In recent weeks, the focus has shifted to hedge funds and brokerages that have engaged in billions of dollars of credit derivative and other long-term trades with funds and institutions all over the world.
Trading in credit-default swaps, in which financial institutions agree to make payments to a counterparty if different kinds of bonds default, has exploded in recent years.
Among commercial banks alone, the notional value of such swaps outstanding hit $14.4 trillion in the fourth quarter, up 58% in the past year and more than triple the amount outstanding since mid-2005, according to data provided by Bianco Research.
If a major Wall Street firm goes out of business, investors and financial institutions who have long-term derivatives contracts with it could find themselves exposed to risks they thought they had offloaded. In some cases, they may find themselves exposed to counterparties they didn't even know.
Analysts say Bear's troubles illustrate how speculation can lead to very real problems at a major financial institution, which can be exacerbated by market turmoil.
"We moved $25 billion of our clients' assets in the last three months to other prime brokers," said Robert Sloan, a managing partner of New York-based S3 Partners LLC, a financing specialist that advises hedge funds on prime-brokerage relationships. Overall the firm advises on about $100 billion in hedge-fund assets.
Friday, some debt investors also became more cautious about Lehman Brothers Holdings Inc., another Wall Street firm that has substantial mortgage and fixed-income exposures. The cost of five-year credit-default protection on Lehman's debt rose to $450,000 annually for every $10 million in debt, up from $395,000 a day earlier.
Investors who wanted to buy this protection on Bear Stearns debt at one point had to fork out as much as $1.1 million upfront to sellers and agree to pay $500,000 annually for five years for the insurance. Thursday, that insurance cost buyers $675,000 annually with no upfront payment, according to data from Phoenix Partners Group.
If a major financial institution goes under, that could have "ripple effect among counterparties and a cascading effect on security prices for investors," said Carlos Mendez, senior managing director at Institutional Credit Partners, a boutique investment firm in New York. "There is a distinct possibility of more failures in the $45 trillion derivatives market and that's scary to think about."
The fate of Bear Stearns could matter greatly to the many governments, hedge funds, pension funds and other investors who entered into derivatives contracts with the brokerage firm.
Bear has been particularly active in one type of popular derivative, known as an interest-rate swap. The notional amount of these contracts is estimated to be in the hundreds of billions of dollars, according to Swap Financial Group, a South Orange, N.J., advisory firm that specializes in derivatives.
Some of the investors engaged in these swaps with Bear are better positioned than others. Bear created two subsidiary companies, known as special-purpose vehicles, with a separate legal status intended to make their obligations secure even if the parent company goes bankrupt. These SPVs are triple-A-rated, and their management would be assumed by another brokerage firm if Bear collapsed.
But many other investors entered into swaps with a direct subsidiary of Bear that would be more acutely exposed to the firm's future.
"Those are the parties at greater risk of not getting out [of the swaps] whole," said Peter Shapiro, a managing director at Swap Financial.
—Craig Karmin contributed to this article.
source: p.B1 15mar2008
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