FYI | Mar 17 2008
By Greg Peel
Stunning.
Only this morning (Australian time) the Wall Street Journal reported the inside running was that JP Morgan would pick up Bear Stearns for US$2.2bn, or US$20 per share. This would supposedly have been a bargain, particularly given Bear’s New York premises alone is meant to be worth US$1.2bn. Bear Stearns shares last traded at US$30 on Friday.
Now it has been reported that JPM has secured Bear for a mere US$236.2m, or US$2 per share. No cash – all scrip. One assumes JPM must have opened up Bear’s books on Sunday and found so much trash – unsaleable asset-backed securities – that there was no real value in the company at all. And most of Bear’s counterparties must have pulled their cash out on Friday, if they hadn’t already. JP Morgan has stated it will assume all counterparty risk. Which begs the question: At what point last week was Bear Stearns actually insolvent? The purchase price represents a 97.5% discount to Bear’s reported book value of US$80ps. The firm’s employees own 30% of the company.
The Fed took the step of providing a facility to Bear Stearns on Friday, via commercial banker JP Morgan. In so doing, JPM assumed no risk – the American people did. It’s all academic now as Bear Stearns disappears onto JPM’s balance sheet like a penny dreadful bolt-on.
The astounding sale is sure to send shockwaves through the US market. If Bear is worth only US$2, what are others worth? It’s a trade off between sheer uncertainty and the knowledge that the Fed is there to make sure no one goes belly up. One thing’s for sure – there will not be a sudden rush to rationalise the US banking industry further. Anyone who may have been eyeing off a cheap entry point – be it a billionaire, private equity firm, sovereign wealth fund or Wall Street competitor – will now have recoiled in astonishment.
And questions are being asked of the Fed’s actions – not just the Bear Stearns facility, but of the extensive liquidity being offered at extended maturities and for an extended range of debt instruments. It seems that Bernanke’s ploy is to facilitate bail-outs on the “asset side of the balance sheet”, as reports are suggesting, rather than being forced to counter with an enormous rate cut that would otherwise be needed to “square the circle” of open market operations. In so doing, the inflation effect, which would otherwise be substantial, is mitigated.
But thus it also amounts to an effective equity purchase. In a roundabout way, the Fed is nationalizing the banks. Northern Rock has been nationalized by the Bank of England, but the Fed is up to amounts to a massively greater investment on behalf of the US tax payer than Northern Rock represents.
What the Fed has also done this morning (Australian time) is cut the discount rate by 25 basis points, from 3.5% to 3.25%, closing the gap over the cash rate to only 25bps. Before the credit crisis began, the gap was 100bps. The discount rate is the rate at which commercial banks can go to the Fed for emergency liquidity – the same facility that allowed the Fed to prop up Bear Stearns via commercial bank JP Morgan.
The market is still expecting a big cut in the cash rate tomorrow night, possibly a full 100bps, or 1%, to 2%. Some analysts expect the Fed will ultimately keep on cutting down to 1%, just as it by 2004 did under Alan Greenspan’s chairmanship . This was the end result of trying to save the US economy following both the tech wreck and 9/11. The 1% interest rate has also been held responsible as a key reason the whole mortgage-backed security bubble was able to form, driving US house prices through the roof over the next two years. The circle would be complete.
The remainder of the large US investment banks will announce their first quarter earnings this week. Goldman Sachs is the Daddy of them all, and has surprised the market throughout the credit crunch by not having to write down very much at all. Not only did Goldmans eschew what it saw as a foolish CDO bubble, it shorted such instruments.
But now that the credit crunch has moved well on from the original subprime mess, Goldmans has been hit elsewhere. The firm is expected to announce a US$3bn first quarter write-down tomorrow night, along with a 50-60% loss for the quarter. The bulk of the loss comes from loans to private equity deals, and from its investment in China’s ICBC Bank. Not even the canny Goldmans is immune from this disaster.
Lehman Bros is also expected to announce more write-downs tomorrow night – in its case US$2bn. On Wednesday night, Morgan Stanley is expected to announce a US$500m write-down.
If the numbers come out worse than expected, then the excrement may well hit the rotating cooling device.
