The bear market for Bear Stearn assets

Wall Street Journal Editorial:

The best thing about Sunday night's Federal Reserve-inspired sale of Bear Stearns to J.P. Morgan Chase is the price. At $2 a share for a total of $236 million, this was less a "bailout" than a Fed-mediated liquidation sale. Bear wasn't too big to fail after all, though there's still the issue of the Fed expanding its own moral and financial hazard in the form of $30 billion in guarantees on Bear Stearns securities.

Bear shareholders will essentially be wiped out in this close-out sale, with British billionaire Joseph Lewis alone reportedly enduring paper losses of $800 million on his 9.6% stake. Even on Wall Street, that's real money. Jimmy Cayne, the Bear Chairman and former CEO who supervised this disaster, will lose a bundle on his nearly 5% holding. This makes the Bear sale different from the Fed-managed Long-Term Capital Management rescue of a decade ago, when investors were left substantially intact. We doubt many bankers will look at Bear's fate and claim there's no punishment for financial error.

Bear employees, who hold about one third of its shares, are angry and grousing that they could get more cents on the equity dollar in Chapter 11. Some may even be inclined to vote against the sale, but then they'd have to find a market for that $30 billion in mortgage securities that no one wants to finance.

The hard capitalist truth is that Bear's most senior managers have mainly themselves to blame. They bought their second or third homes with fabulous bonuses during the good times, and they must now endure the losses from Bear's errant investment bets. Bear took particular pride in its risk management, but it let its standards slide in the hunt for higher returns during the mortgage mania earlier this decade. There's no joy in seeing a venerable firm expire, but it has to happen if financial markets are going to have any discipline going forward.

As for J.P. Morgan and CEO Jamie Dimon, remind us to have him negotiate our next contract. He gets Bear's best assets, including a Manhattan building said to be worth $1.4 billion by itself. Meantime, he gets the Fed to backstop Bear's riskiest paper. We don't know the quality of that paper -- and we hope the Fed has done its due diligence -- but taxpayers are now on the hook for future losses. Some previous Fed officials might have told Mr. Dimon to take all of Bear or nothing at that $2 liquidation price, but Ben Bernanke and Tim Geithner of the New York Fed seem to have been desperate to get a sale announced before markets opened on Monday. Mr. Dimon took them to school.

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There is more on the contribution of the Fed to this deal which was a substantial assumption of the risk in the Bear Stearns' portfolio. Still the old saw about the assets of an investment banking firm riding up and down the elevators everyday is still true and with the losses those "assets" have incurred in their own holdings it may be difficult to keep them on the same elevators. The layoff which will follow the acquisition will be in the non production areas like the back office and administrative jobs.

The firm was a victim of its own investment decisions and risk management, but it was also a victim of the decision of thousands of people who decided to walk away from their mortgage obligation. Would a bailout of these former home owners have saved Bear Stearns? Probably not. What cannot be reasonably argued is that this deal was a bailout of a Wall Street firm. It was a liquidation at a fire sale price in hopes that the credit markets would continue to function. The Fed is making a huge bet on those markets. It is a bet that Bear Stearns already lost.