The New York Times reported a blockbuster revelation from yesterday's Congressional testimony on the JPMorgan Chase & Co. (NYSE: JPM) acquisition of The Bear Stearns Companies (NYSE: BSC). It turns out that the religious right and government bailouts go hand in hand -- that's because Treasury Secretary Hank Paulson decided that he would not put $30 billion worth of taxpayer money at risk unless JPMorgan paid a really low price for Bear.
The reason? Moral hazard. Specifically, Paulson wanted to use Bear as an example that would scare all the other banks that borrowed $32 for every dollar of equity to buy Collateralized Debt Obligations (CDOs) and other difficult -to-value securities. Paulson wanted to wipe out Bear shareholders so they would be reluctant to seek government help if they got into trouble.
And another thing. Alan Schwartz, Bear's CEO, claims to have misunderstood and thought it was a 28-day loan granted on Friday 14th. This would have given him a month to straighten things out. But he later learned that the loan lasted only for the weekend. And he would need to file for bankruptcy or accept the deal that Paulson was offering. Faced with two terrible choices, Schwartz took the Paulson deal.
How much will taxpayers lose due to Paulson's moral qualms? Was this really necessary? Wouldn't the 28-day loan have avoided this?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 1)
4-04-2008 @ 9:51AM
John said...
I watched the entire hearing.
1.) Paulson did NOT say anything about a "low price". Jamie Dimon put the number out there because to quote him, "it is one thing to buy a house at a fire sale, and another to buy a house on fire". JPMC examined Bears books for 48 straight hours with a combined staff of almost 1000 people. JPMC took Bear's book value as of Mar 14 for valuation.
2.) Schwartz said, "I understood the loan was to be for up to 28 days". Bear's financial condition deteriorated from Wednesday morning to Thursday night by capital on hand going from 12 billion to 2 billion and the common stock going down 50%. On Friday, Schwartz called Geithner at the NY Fed and told him that unless something could be done immediately, Bear would be bankrupt Monday. The NY Fed called the loan due to the impending bankruptcy and notified JPMC of the problem. Dimon, of JPMC, sits on the Board of the NY Fed.
3.) The perceived "bailout" by the Fed is anything but. JPMC bought 300 billion worth of Bear's assets, takes the first 1 billion in losses, and borrowed 25 billion at the discount window on behalf of Bear. The Fed is getting 30 billion worth of "investment grade" notes, NOT just mortgages, and has JPMC on the hook for 26 billion of it.
4.) The amount of money involved here is equal to a.) 2 months of war mongering costs in Iraq. b.) 1/2 of the amount of the latest foreign policy grants to African countries. c.) 1/4 th of the "earmarks" passed along with bills in the 2007 legislation.
4-04-2008 @ 10:05AM
B. Harrison said...
Well that does put the JP Morgan deal into a little different perspective"
Moral hazard. Specifically, Paulson wanted to use Bear as an example that would scare all the other banks that borrowed $32 for every dollar of equity to buy Collateralized Debt Obligations (CDOs) and other difficult -to-value securities. Paulson wanted to wipe out Bear shareholders so they would be reluctant to seek government help if they got into trouble.
But wouldn't Bear Stearns failure" have accomplished the same thing > Now the buzzards are circling around the other weak companies just waiting for their chance to make out like JP Morgan.
Paulson may have sent a mixed signal to the market.
4-04-2008 @ 12:03PM
Gregg M. Boore said...
Moral hazard, eh ? That's hilarious. So is Jaime Dimon sitting on the board of the NYFED.
Gee, I wonder if there is a conflict of interest here ?
These gentlemen are all the same. Mr. Paulson knows less than nothing, though I can't say that for Mr. Dimon.
What should have happened is to allow BSC to go under. The CDO's had no value anyways and they obviously overwhelmed the other profitable biz segments in BSC.
Fact is, this is all going to come back. The effects on the economy are occurring NOW ! They just made a bad situation worse.
Too bad none of them knows how to speak Japanese.
4-06-2008 @ 11:16AM
thenakedtrader said...
Sure, now that the panic of a financial industry meltdown is over, everyone's now second-guessing the Fed's and Treasury's actions and saying they should've let Bear go bankrupt.
It's easy to say that in hindsight, but still wrong imho... what such 'experts' don't seem to understand is that, if BSC had gone bust, their counterparties to their positions (e.g. other investment banks or hedge funds on the other sides of BSC's trades) could have liquidity problems due to BSC's obligations to them tied up in bankruptcy court. There then could be a cascading series of bankruptcies, undermining the stability of the financial system. imho, THAT is why the Fed and Treasury felt they had to act.
What is also missed by some of the critics is that JPM's guarantee to back BSC's trading obligations had significant value, not just to BSC, but to orderly financial markets. If BSC's trading desk had to shut down because firms refused to trade with them (because of the bankruptcy risk), the value of their trading business would go to ZERO.
The people I feel for are BSC's employees and shareholders... they have every reason to feel shafted. But consider this... if BSC were allowed to go bankrupt, there's every reason to expect that they (not to mention the rest of us investors) would have come out far worse....