One foot in the Bear trap: Part 1, ouch!
[Editor’s note: we interrupt the multi-part post on water and sanitation for breaking news regarding the Bear Stearns/ JP Morgan Chase shotgun marriage, which is too delicious to ignore and too timely to defer. We’ll return to water later in the week.]
Although it’s only tangentially related to housing, I have to post about the recent ultra-intense marriage between JP Morgan/ Chase and Bear Stearns, with the Federal Reserve acting as matchmaker and a large shotgun cradled easily in its arm. The story’s full of its revealing flashes about the nature of our current credit gridlock, and insights hardball market negotiations.
One of us is just an interested third party
What ate the Bear?
Lack of cash ate the Bear.
Out of cash? Out of cash?
When you’re running an engine hot, you need enough crankcase oil to lubricate that furiously rotating and cycling machinery. If you run dry, the block seizes, the car crashes.
Good only for being a boat anchor
For a bank, the crankcase oil is cash liquidity. Having net equity is secondary; you can’t make payroll with accounts receivable, accrued income, or non-cash assets held in inventory.
A little cash infusion keeps it lubricated
Late last week, Bear’s temperature gauge shot up past critical, so Bear had to find a better-capitalized suitor.
Who ate the Bear?
With the Federal Reserve’s active matchmaking, it hastily found an eligible groom in JP Morgan/ Chase, so a deal was swiftly struck. Perhaps too swiftly, for as reported in The New York Times, Bear’s shareholders balked – ingrates! – believing they were being exploited in their hour of need:
Two bucks a share!!?
Inside Bear, the vitriol over that bargain-basement price was palpable last week. Bear employees own more than a third of Bear’s stock, and many longtime employees faced the prospect of losing all their savings. On Monday, some were seen crying in the hallways of the firm’s Midtown Manhattan headquarters.
My grandfather worked twenty-five some-odd years for the Saturday Evening Post, and when it went under, there went a quarter-century’s pension. Out of his small financial tragedy, and millions like it, came ERISA — The Employee Retirement Income Security Act, which mandated properly funding pensions. The market then shifted, covering the pension in investable cash but offering incentive compensation in the form of restricted stock. Employers like this because not only were the shares or options non-cash, they also could be vested over several future years, in effect creating a large cumulative penalty for leaving the firm. Conversely – and this may be an unintended benefit – having employees as principal owners gives them a veto and a voice, and they used both:
One employee started a Web site to rally opposition to the deal. Some employees said they talked back to their new supervisors from JPMorgan, which commandeered desks and conference rooms after being given operational control of the firm last week.
Before its recent meltdown, [Bear’s shares] were trading at about $67 two weeks ago and as high as $170 a year ago.
Even measured by measured implosions, that’s an extraordinary price collapse. Most people, without even looking at the books, would conclude that price is too low, driven by lack of liquidity and market panic.
Even after JPMorgan announced that it would acquire Bear for $2 a share, investors bid up the stock to close at $5.96 on Friday in anticipation that a better deal would be reached.
A condemned man is curiously liberated to threaten to take others with him, and in those high-pressure days, Bear’s shareholders made such threats:
Some of Bear’s largest shareholders have even considered voting down the deal to send the firm into bankruptcy protection, where they speculate they might get more than $2 a share from creditors.
Bankruptcy’s a strange netherworld of litigation goo and disorienting financial logic, but there’s one lodestar to pursue – nobody in a bankruptcy gets more than he deserves. Bankruptcy exists to protect the unsecured creditors and common shareholders by calling a halt to any fire-sale trading and compelling the markets to give a company time to recover its financial wits.
A few months in Chapter 11 will clear my head
The British billionaire financier Joe Lewis, the firm’s largest shareholder, who had invested $1.26 billion in Bear over the last year at an average price of about $104, said in a filing with the Securities and Exchange Commission that he would seek to block the deal by taking “whatever action” necessary and would “encourage” the firm and “third parties to consider other strategic transactions.”
If I owned 12,100,000 or so shares, I’d fight about the difference between $2 and something higher. Wouldn’t you?
I invested in this firm in 1898, sir, and by gad I’ll fight your price
It’s not as though the $2 per share price had been established through calm reflection:
[It was] a tumultuous week on Wall Street and in
While the initial agreement appeared to have defused the financial crisis of confidence that undid Bear, the initial terms of the deal — and the government’s controversial role in reaching them — drew criticism from those who say the takeover amounts to a government bailout of Bear, a firm at the center of the mortgage meltdown.
Like the proverbial shotgun marriage, this one was arranged from outside:
As part of the original deal, the Fed guaranteed to take on $30 billion of Bear’s most toxic assets.
It reads like a Regency novel: the spendthrift maiden had run up debts all around town, and her glowering father would stand surety for them, provided the wild young lady got herself respectably married. Enter the modest sober suitor:
The central bank also directed JPMorgan to pay no more than $2 a share for Bear to assure that it would not appear that the Bear shareholders were being rescued, according to people involved in the negotiations.
Assuming this is right, the Fed told Bear that it couldn’t pay anything more than a de minimis price because doing so would look bad. (I’m parodying only slightly – the risks of moral hazard are real.)
A spokesman for the Federal Reserve would not comment on the central bank’s involvement in the negotiations and denied that it had directed the original sale price.
Well, they would deny, wouldn’t they? I doubt we’ll ever know.
“Follow the money”
JP Morgan/ Chase, the Fortinbras of this particular tragedy, began its new venture by playing the reluctant heir:
Last week, in an impassioned speech to Bear’s employees seeking their support, Mr. Dimon said: “No one on Wall Street could have anticipated this. I feel terrible sometimes when people think we took advantage. I don’t think we could possibly know what you all are feeling, but I hope that you give JPMorgan a chance.”
We’ll give you a chance, all right
Even as it was soothing an angry mob of employees, JP Morgan/ Chase sought frantically to get the bride to the altar and the vows exchanged:
As it began to look more possible late last week that the deal might be struck down, Mr. Dimon became increasingly desperate in recent days. He offered certain employees cash and stock incentives to stay on and made calls to his rival chief executives on Wall Street — John J. Mack at Morgan Stanley and John A. Thain at Merrill Lynch, among them — pleading with them not to recruit Bear employees during the transition.
There’s very little point in buying a going concern if all the people who make it go are gone.
Mr. Dimon had became convinced that the deal was in jeopardy after spending much of last week taking angry calls from Bear’s largest shareholders, including Mr. Lewis, these people said.
Yes, your call is very important to us
Yes, I will be personally responsible for your happiness
Moreover, Mr. Dimon, who had indignantly told associates that he would “send Bear back into bankruptcy” if the deal was struck down, was persuaded by his advisers that he had less leverage than he thought, according to people briefed on the conversation. Such vindictive behavior, they told him, would turn into a legal and public relations nightmare.
There was also, if the reports are true, another reason [hat tip: Volokh Conspiracy], one a whole lot more dangerous than bad public relations:
JPMorgan and Bear were prompted to renegotiate after shareholders began threatening to block the deal and it emerged that several “mistakes” were included in the original, hastily written contract, according to people involved in the talks.
I didn’t get to be chief executive by forgiving mistakes
‘Mistakes,’ we can hear Mr. Dimon repeating with an ominous purr in his voice. ‘What kind of mistakes?’
One sentence was “inadvertently included,” according to a person briefed on the talks, which requires JPMorgan to guarantee Bear’s trades even if shareholders voted down the deal.
Ooo, I really wouldn’t want to be the lawyer who had to tell Mr. Dimon that, for it violates one of the absolute bedrock principles of trading: simultaneity of exchange.
The essence of a trade is simultaneity: I give you what you want, you give me what I want, at the same instant. In formal transactions we do this with escrow agents. In informal or illicit transactions, they do it while pointing guns at each other.
I guarantee your trades, you guarantee you’ll sell, right?
Here, if the story is correct, either JP Morgan or its lawyers blew it big time. Bear went in to this transaction reluctantly, with the prize being access to liquidity and a guarantee of its business lines.
A major aim of a new agreement would be to provide assurances to investors who trade with Bear that it will continue to be open for business. Even with JPMorgan’s original agreement in place last week, some of Bear’s largest customers would not trade with it, still nervous that the deal might unravel.
True enough, but if you are being paid to rescue someone, make sure you’re paid before you do the rescue. JP Morgan had done the good deed without getting that necessary signature.
‘Do you mean to tell me,’ we can imagine Mr. Dimon’s voice rising, ‘ that we’ve given them what they wanted before they close? Before they’ve even made a binding COMMITMENT?’
If you don’t close, I’m going to have a vulture eat your entrails for all eternity
That provision could allow Bear’s shareholders to seek a higher bid while still forcing JPMorgan to honor its guarantee, these people said.
When the error was discovered, James Dimon, JPMorgan’s chief executive, who was described by one participant as “apoplectic,” began calling his lawyers at Wachtell, Lipton, Rosen & Katz to seek a way to have the sentence modified, these people said.
‘Sir,’ we imagine the sweating lawyer replying in a strangled voice rising to a squeak,’ would you relax your grip on my testicles?’
Finger pointing over the mistakes in the contracts began as bankers blamed the lawyers and vice versa.
Now squeeze! Squeeze hard!
Finger pointing will be the least of Wachtell Lipton’s worries. If these reports are true, they will be lucky to get out of this deal for zero fee and a release, because immediately thereafter, the renegotiation happened fast and furious
JPMorgan Chase was in talks on Sunday night for a deal that would quintuple its offer for Bear Stearns, the beleaguered investment bank, in an effort to pacify angry Bear shareholders, according to people involved in the negotiations.
Under the terms being discussed, JPMorgan would pay $10 a share in stock for Bear, up from its initial offer of $2 a share — a figure that represented a mere one-fifteenth of Bear’s going market price.
Ten bucks a pop still looks like a bargain compared to $67, but it looks a whole lot less like pillage than did the original $2 a share.
Just a friendly little discussion of asset values, that’s all
If the price is increased, however, some critics could have more ammunition to complain that taxpayers are helping to bail out a Wall Street firm that should be responsible for its own risky behavior. That is one reason the Fed was hesitant on Sunday night to approve the transaction at $10 a share, people briefed on the talks said.
Agree, however, the Fed did. As CNN reported Monday:
JPMorgan Chase (JPM, Fortune 500) agreed Monday to quintuple the value of its all-stock offer for Bear Stearns, to $10 a share. The revamped agreement, valued at $1.18 billion, comes just a week after JPMorgan agreed to buy the cash-strapped brokerage firm with backing from the Federal Reserve. The deal staved off a probable Bear Stearns bankruptcy that threatened to swamp the financial sector with a new wave of uncertainty.
This wasn’t the only agreement made Monday:
You see my argument?
[Continued tomorrow in Part 2.]
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