Will the Deal Last?
After denying reports about the bank’s huge liquidity crisis several times, Bear Stearns finally confirmed in March that it had accepted emergency lending from JPMorgan Chase.
Initially, JPMorgan, the third largest bank in the U.S., described the deal as temporary funding to bail out Bear Stearns. Later, however, JPMorgan announced that it had agreed with the U.S. Government on a plan to buy the investment bank.
Accordingly, the 85-year-old investment bank was sold for $2 a share, or $236 million — 6% of its market value — with the U.S. Federal Reserve approving funding for up to $30 billion of Bear’s less liquid assets.
The collapse of the bank’s share price, from a peak of $169 to $2, meant that the hardest hit were the bank’s own employees, who owned about a third of the company.
On March 24, JPMorgan surprisingly increased the buy-out offer to $10 per share, or $1.2 billion total.
The main reason for the revision may have been to help JPMorgan overcome frustration among Bear’s employees and shareholders, and to prevent the exodus of the investment bank’s trading partners.
The revision in the deal also gives JPMorgan greater hope that it will actually last.
What Caused Bear Stearns’ Troubles?
Bear Stearns, the fifth largest U.S. investment bank, was founded in 1923. Before the crisis, it had a market capitalization of $17 billion, assets worth $385 billion, and employed around 15,000.
Bear Stearns’ problem stemmed from the overall loss of confidence in the credit markets.
The company’s heavy investments in subprime mortgage instruments and highly risky securities also led to its fall from grace. The bank failed horribly when the value of its mortgage-backed securities, which comprised an unknown number of troubled subprime loans, plunged.
The liquidity crisis in the last year caused the collapse of the investment bank’s hedge funds. In September of last year, the bank declared a 61% drop in its net profits.
Why Are Markets Panicking?
The collapse of a premier Wall Street bank has made it clear that no one is immune to the subprime tragedy that is wreaking havoc on real estate and stock markets.
The fact that Bear Stearns became a victim of the liquidity crisis has caused nervousness in the market and made observers wonder if it will trigger a chain reaction of defaults.
The bank’s collapse has also dealt a big blow to the confidence in credit markets that are already reeling from sliding housing values and rising incidents of mortgage foreclosures.
The Shift in the Fed’s Policy
Earlier, the government had intervened only to protect highly regulated commercial banks. The Fed’s latest step in helping Bear Stearns, an investment bank, is proof of their indispensability in today’s market.
The move is likely to arrest the disaster, preventing further significant harm, but it may not succeed in curing the housing-driven credit crisis that is currently ruining the nation's economy.
