By LANDON THOMAS Jr.
Published: March 15, 2008 -
Just three days ago, the head of Bear Stearns, the beleaguered
investment bank, sought to assure Wall Street that his firm was safe.
But those assurances were blown away in what amounted to a bank run at
Bear Stearns, prompting JPMorgan Chase and the Federal Reserve Bank of
New York to step in on Friday with a financial rescue package intended
to keep the firm afloat.
The move underscores the extreme stresses that the credit crisis has
imposed on the financial system and raises the once-unthinkable
prospect that major Wall Street firms might fail.
The developments may only postpone the eventual sale of all or part of
Bear Stearns, which has had crippling losses on mortgage-linked
investments. To keep the 85-year-old firm solvent, JPMorgan, backed by
the New York Fed, extended a secured line of credit that gives Bear
Stearns at least 28 days to shore up its finances or, more likely, to
find a buyer.
News of the bailout ignited fears that other big banks remain
vulnerable to the continuing credit crisis, and stocks tumbled in
another rocky day for the markets. Financial shares led the way, with
shares of Bear Stearns plunging 47 percent. Hours after the rescue was
announced, another Wall Street firm, Lehman Brothers, said it had
secured a three-year credit line from banks. Its stock fell 15
percent.
Policy makers are likely to spend the weekend dealing with the fallout
in the financial system, and potential buyers are already circling
Bear Stearns.
As the Wall Street drama unfolded, Ben S. Bernanke, the Federal
Reserve chairman, added fresh warnings Friday about a gathering wave
of home foreclosures bearing down on American communities.
President Bush, meantime, made his most striking acknowledgment yet of
the country's economic troubles, even as he defended his
administration's responses so far and warned against more drastic
steps by the government to intervene.
"Today's events are fast moving," he said, "but the chairman of the
Federal Reserve and the secretary of the Treasury are on top of them
and will take the appropriate steps to promote stability in our
markets."
The rescue effort began late Thursday evening, when Alan D. Schwartz,
Bear Stearns's chief executive, placed an urgent call to James Dimon,
his counterpart at JPMorgan Chase. Mr. Schwartz said Bear Stearns was
struggling to finance its day-to-day operations, according to several
people briefed on the negotiations, a situation that would threaten
its survival.
Because JPMorgan settles transactions for Bear Stearns as its main
clearing bank, it was in a good position to *****s the collateral that
Bear Stearns could provide against a loan. But Mr. Dimon insisted on
the sup****t of Timothy F. Geithner, president of the New York Fed. Mr.
Geithner quickly agreed to the plan.
Assisted by Gary Parr, a top investment banker at Lazard specializing
in financial companies, Mr. Schwartz and Mr. Dimon spent the night
negotiating the deal, which was not sealed until the early hours of
Friday.
The size and terms of the credit line were not disclosed. JPMorgan
will borrow the money from the Fed and lend it to Bear Stearns, and
the Fed will ultimately bear the risk of the loan.
Meetings between Bear Stearns and prospective suitors have already
begun. Interested parties include J. C. Flowers & Company, the private
equity investor, and Royal Bank of Scotland, according to people who
were briefed on the discussions.
The Fed's intervention highlights the problems regulators face as they
contemplate the prospect that investment banks, saddled with toxic
securities tied to subprime mortgages, are losing the trust of their
lenders and clients -- the kiss of death on Wall Street, where
confidence has always been the most precious asset of all.
Traditionally regulators have helped commercial banks in financial
panics, but not investment banks, which do not hold customer deposits.
But the 1999 repeal of the Glass-Steagall Act, the Depression-era law
that separated investment banks and commercial banks, led to
consolidation within the financial industry that has made such
distinctions harder to make.
"I don't remember a Fed action aimed at a noncommercial bank; this is
the kind of thing you see in this post-regulatory environment," said
Charles Geisst, a Wall Street historian at Manhattan College.
The developments represent a devastating blow to Bear Stearns, which
has carved a niche by mastering the financial arcana of the mortgage
market. But after two of its hedge funds that specialized in the
subprime mortgage market collapsed last summer, Bear Stearns's area of
strength became a millstone.
In a conference call on Friday, Mr. Schwartz, who succeeded James E.
Cayne as chief executive early this year, sounded frustrated as he
described the run on Bear Stearns over the previous 24 hours, and
raised the possibility that the firm's days as an independent bank
were numbered.
"This is a bridge to a more permanent solution and it will allow us to
look at strategic alternatives that can run the gamut," he said.
"Investors will be able to see the facts instead of the fiction. We
will look for any alternative that serves our customers as well as
maximizes shareholder value."
Only days earlier, Mr. Schwartz, a well-connected investment banker
who has been at Bear Stearns since the early 1970s, appeared on
television to try to calm market fears that the bank was in trouble.
Skittish lenders were already calling in loans made to Carlyle
Capital, a bond fund sponsored by the Carlyle private equity group, as
well as Thornburg Mortgage, a major mortgage firm. Soon the attention
spread to Bear Stearns as market players began to question the firm's
ability to finance itself, sending its stock into a tailspin.
By late Thursday, Bear Stearns's top lenders and its hedge fund
clients were calling the firm and demanding their cash back, perhaps
encouraged by Mr. Schwartz's comments that the firm's capital and
liquidity were strong.
Mr. Schwartz said on Friday that he hoped to find a long-term solution
as soon as possible. At its closing price of $30 a share on Friday,
Bear Stearns was trading at a gaping discount to its re****ted book
value of $80 a share. Mr. Schwartz said that Bear Stearns, which moved
up the re****ting of its first-quarter results to this Monday, is still
likely to have a result in the range of analyst estimates, suggesting
a profit and a slight expansion of its book value, the truest measure
of its financial condition.
Questions persist, however, concerning the real value of its remaining
assets.
While Bear Stearns has valuable businesses like its hedge fund
servicing and back office unit, as well as aspects of its real estate
operations, they are unlikely to command a high price given the
current market. But Mr. Dimon, despite having expressed reservations
on buying another investment bank, could bid for all or part of Bear
Stearns at a discounted price. Bear Stearns might accept his offer if
it cannot solicit a competing bid.
The troubles at Bear Stearns have come quickly and savagely and hurt
some of the putatively smartest money in finance. From Joseph Lewis,
the Bermuda-based billionaire who bought $1 billion of Bear Stearns
shares last summer, when the stock was trading at $100 and above, to
William Miller, the vaunted value investor at Legg Mason, those who
have wagered on a turnaround at Bear Stearns are many.
As the smallest of the major Wall Street banks, Bear Stearns disdained
the big bets that its larger competitors made and ****ed away from
trendy markets like Internet stocks in the 1990s.
But as its core mortgage business flourished during the housing boom
from 2003 to 2006, Bear Stearns, under the guidance of Mr. Cayne,
suc***bed to the fervor of the time. Bear Stearns's stock price soared
and hit a high of $171, making Mr. Cayne, who owns 5 percent of Bear
Stearns, a billionaire for a brief moment.
The demise of the hedge funds began a slow but persistent loss of
market confidence in the bank. Such an erosion can be devastating for
any investment bank, especially one like Bear Stearns, which has a
leverage ratio of over 30 to 1, meaning it borrows more than 30 times
the value of its $11 billion equity base.
"The public has never fully understood how leveraged these
institutions are," said Samuel L. Hayes, a professor of investment
banking at Harvard Business School. "But the market makers understand
this inherent risk. This is a run on the bank, just like Long-Term
Capital Management, Kidder and Drexel Burnham."
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