WASHINGTON—The run on investment bank Bear Stearns Companies, Inc. by panicky investors—listening to Wall Street rumors about impending doom—completely changed the way Wall Street does business.
In a deal that will be remembered for decades, the U.S. Federal Reserve set new precedence for bailing out firms that take too much risk.
It didn't take any arm-twisting to call in JP Morgan Chase & Co. (JPM) to the rescue. Being a commercial bank, JPM can borrow at the Fed's discount window at a lower interest rate, something that has until now, eluded investment firms.
The U.S. stock market went into a nosedive when JPM announced that it would exchange 0.06 shares of its common stock per one share of Bear stock, amounting to around $2 per share on March 14.
At the same time, the Fed sealed the deal by dishing out around $30 billion to insure some of Bear's less liquid assets.
"The price tag Bear Stearns agreed to be taken out for, about $240 million—less than what the [New York] Yankees paid for Alex Rodriguez—caught nearly everyone by surprise," said Morgan Housel, a writer for the Motley Fool, an online newsletter for investors.
After some speculation by investors, on Mar. 24 JPM increased its offer to around $10 per Bear stock, which was still considered a steal by many analysts.
Current Bear shareholders—many of whom are Bear employees—are clearly the losers in this deal. They will get around five times more money than under the earlier agreement, but still nothing close to the March 14 close price of $54.24.
JPM acquired 39.5 percent of Bear's common stock, becoming its largest stockholder. In return JPM pledged to cough up $1 billion while the Fed will have to write-off $30 billion should Bear's assets prove worthless.
Retirement Plan Predicament
Bear's Employees Stock Ownership Plan holds about 3 percent of its outstanding stock, according to the National Center for Employee Ownerships (NCEO), a not-for-profit organization.
"Bear Stearns is not at all like Enron and some other companies several years ago where employees were heavily or primarily invested in company stock, generally in their 401(k) plans, and were left with limited or no retirement assets after their companies melted down," said Corey Rosen, NCEO Executive Director in a press release.
The plan, funded by Bear, comprised only a small portion of Bear's overall retirement plan.
Law firms have jumped into the frenzy. They are actively encouraging clients to sue trustees of Bear's Ownership Plan, taking advantage of a loophole. Trustees are usually exempt from any legal responsibility if stocks take a nosedive. However, the trustees are on the hook if they knew or must have known that the stock would go into a tailspin.
"Over the years many Bear Stearns employees would have left [the Plan] and been paid out substantial benefits. For those remaining however, the loss will be almost total," claims Rosen.
Wolf Haldenstein Adler Freeman & Herz LLP sent out a press release on Mar. 18 announcing its investigation of trustees of the Plan under the assumption that they may have or should been aware of Bear's exposure to risky investments.
A 'Most Lucrative' Deal
Experts are of differing opinions concerning the Fed's saving Bear from bankruptcy.
Some believe that investment banks will become more risk-averse and perform deeper risk management procedures before jumping into risky investments. Others are skeptical, claiming that investment banks would may more aggressive, as bailout packages would be handed out—at the taxpayers' expense—should they falter.
"The Fed wisely forced a shotgun marriage with J.P. Morgan chase, kicking in a $30 billion federal dowry," said a recent Kansas City Star article.
Analysts see it as a Wall Street welfare program, especially as rumors surface regarding "the next Bear Stearns." Rival investment bank Lehman Brothers Holdings Inc. was often mentioned by speculators.
Housel suggests that the marriage between JPM and Bear was a smart move under the circumstances, as JPM's balance sheet was stronger than most of its industry competitors.
The Fed took by far the greatest risk. Under the latest agreement, JPM only stands to lose around $1 billion, transaction costs notwithstanding. That's a small amount compared to the taxpayers' loss if Bear collapses.
Housel includes in her discussion the dowry Bear brings to this marriage, such as the "45-story Madison Avenue headquarters," with an estimated value of $1.5 billion. Besides Bear's lucrative prime brokerage business, JPM will also get "two of the major Bear Stearns units: investment banking and wealth management," also highly profitable divisions.
"If JPM can pull [Bear] back to even a fraction of its former self, the acquisition will go down in history as one of the most lucrative deals ever made," said Housel.
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