UPDATE: The Wall Street Journal published the third part of a three-part series on Bear’s collapse today. In the aggregate, the three parts made for a fascinating account of the events. I cannot recommend them more highly. In the third part, the authors discussed some of the events leading up to JP Morgan’s agreement to raise the final price for Bear from $2 to nearly $10 (see Bear Stearns Neared Collapse Twice).

According to WSJ’s account, the reason JP Morgan agreed to raise it’s price was that

The hurried deal had a loophole that could give angry Bear Stearns investors powerful leverage to seek a higher price: J.P. Morgan had pledged to finance Bear Stearns’s trades for a year — even if shareholders rejected the deal.

Their explanation seems to suggest that their was a legal clause in the contract that made JP Morgan liable for Bear’s trades in the event that the deal did not go through. That would fall under the “bad lawyering on the part of JP Morgan” explanation.

While that may be partially true, I still believe that JP Morgan’s exposure to Bear as its counterparty on a variety of trades had a little something to do with it too (read on for my take).

————————

I do not know how many of you have continued to follow this story, but Bear Stearns shareholders are set to meet tomorrow to consider, and vote on, the proposed acquisition of Bear by JP Morgan. I was recently interviewed on the subject by German Public Radio. They asked my opinion of the acquisition and the likely outcome of the shareholder meeting. The interview is scheduled to air sometime tomorrow (I will provide an update if a link or a transcript becomes available).

Most of you are likely aware of my opinion of the deal. At the time, I actually saw the transaction as a bailout of JP Morgan more so than a bailout of Bear Stearns (see original post). Although some thought my ideas outrageous at the time, Nouriel Roubini recently expressed similar sentiment, as did Christopher Alleva in a recent post on the blog American Thinker (see Ex-Treasury Department Economist Says Bear Bailout was for JP Morgan).

But I digress. Back to the topic at hand.

The interview began innocuously enough. I was first asked how I thought Bear shareholders should vote. To me, this was a no-brainer. I unambiguously believe that Bear shareholders ought to approve the deal. What’s the alternative – bankruptcy and a share price of $0? At this point no other suitors are likely to emerge, the Fed is unlikely to provide as sweet a deal to any other interested party, and it is unlikely that Bear Stearns could ever restore the Street’s faith in it if it were to try to continue as an independent entity. So I say, just get it over with and accept the terms of the deal. 

We then began to discuss winners and losers in the deal. I thought that quite clearly, JP Morgan came out the winner. They were able to acquire some pretty valuable assets on the cheap, and with the Fed agreeing to absorb up to $29 Billion in losses. Not too shabby a deal if you can find one like it. For me, the losers are the employees of Bear Stearns (the ones who did not have a hand in creating their mess – and my sense is that there were many). These are smart and talented folks who find themselves either out of work, or in limbo, but whichever the case, certainly worse off.

Finally, we touched upon the specifics of the deal itself. The interviewer asked me why JP Morgan raised it’s bid from $2 to $10 per share. My response (and supportive of the sentiment that I expressed in my initial post) was that they likely felt compelled to raise their bid. If, as I argued, JP Morgan had a lot to lose if Bear went bankrupt (in the form of assets that JP Morgan would have been forced to take back onto its own books), JP Morgan had to capitulate and pay up. As long as the potential losses from the troubled assets that JP Morgan would have been forced to take back onto its books were greater than the additional cash that JP Morgan would have to pay, it made sense for them.

Think about it, if JP Morgan had little or no exposure to Bear, why would it have budged? JP Morgan could have easily responded by saying, “$2 is our final offer, and if Bear shareholders don’t like it, too bad, Bear can go bankrupt.” Why did JP Morgan add $8 per share (several billion dollars more) to a deal where without it, the target (Bear) was sure to fail? I’m not sure I can come up with any other explanation than, they had to.

This entry was posted on Wednesday, May 28th, 2008 at 4:51 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.