On Bear Stearns' Demise & Its Purchase By Chase- Part One

Just two weeks ago today, I wrote this post on commercial banking concentration. Little did I know that I would be so close to the truth, and by such a short amount of time.

Rather than the collapse of a commercial bank, it is an investment bank/brokerage- Bear Stearns- that has failed. But the thrust is the same, as has become clear from comments of many pundits in the last 24 hours. And from an analysis of the current condition of financial markets.

As I most recently wrote on the 'mark to market' issue here, a few days after the other linked post,

"As I began to suggest in my earlier post, businesses and companies in the business of trading and investing with the constant expectation of selling and buying securities should probably mark their assets to market daily. If that causes them to use less leverage or avoid exotic structured finance instruments, so be it.

Financial service businesses intending to hold assets, whether they be whole loans, exotics, or what have you, beyond a pre-determined duration, should probably be able to value those assets on the basis of performance, rather than immediate market value."

In essence, Bear Stearns got caught in the former situation, holding large amounts of exotic securities, for which there is no current 'market,' with borrowed money. Between increased demands for collateral and worries over its liquidity, its counterparty risk made it an unsustainable trading entity.

Goodbye Bear Stearns.

Because of the genesis of this current financial turmoil, exotic, somewhat opaque structured finance instruments, I wrote this post last September. In it, I opined,

"Now, with this latest credit market debacle, the first since really heavily asset securitization of mortgages and corporate loans have kicked in, we are learning that there are market conditions under which non-banks may not be viable for very long, if they originate and/or hold volatile fixed income assets.

It's an interesting phenomenon. Who would have guessed that there was life in the old commercial bank model, yet?

Back in my days at Chase Manhattan, our group's boss, Corporate Planning & Development SVP Gerry Weiss, attempted a number of efforts calculated to move Chase into some sort of arrangement with a US investment bank, in order to, as he put it, so to speak,

'get their management in charge of our assets, with the advantages of our regulatory structure.'

Therefore, it's ironic to me that something like this might happen. Sure, Sandy Weill agglomerated a bunch of different piece parts to form the now-unwieldy Citi bank. But Salomon and Smith Barney are now almost lost inside of it. And the bankers remained in power, as the investment banks they took over had been weakened by various events.

Now, it would be possible to see a Chase or BofA take Bear Stearns, for example.
An interesting development in the quest for a viable, efficient, profitable organizational structure with which to transact fixed income businesses."

So I guess I did sort of foresee this development. But, being no particular fan of Jamie Dimon, I wouldn't give him too much credit just yet.

For one, Chase is the only true money center bank left standing which can absorb Bear Stearns right now. Citigroup and BofA both damaged themselves with unwise capital markets activities last year.

Second, it's not clear that Chase has really bought much of value. At $2/share, it would seem that the bank doesn't put more than notional value on the 'assets' it has purchased. Mostly, it seems this is a favor to the Fed and the US banking system, as a sort of quid pro quo for the status Chase enjoys as one of the largest US commercial and money center banks.

Now there are some who allege that Bear's CDO book will eventually become quite valuable, yielding a profit windfall to Chase, and, thus, making Dimon look like a prescient hero in a few years.

If that's true, though, again, it's not through any particular wisdom of Dimon's that this has occurred. If Citigroup had been healthier, there would have been a bidding war. And what is the fairness of making Bear Stearns mark such a book to a non-existent, zero-value market, force it to sell itself to Chase for a song, only to allow Chase to hold zero-value instruments in case they do, and, probably will rebound in value over time?

According to CNBC this morning, the Fed preferred Chase to J.C. Flowers as the rescuer of Bear Stearns.

Why? Perhaps Flowers correctly understood the longer-term value of Bear's exotics, and was willing to pay a bit more than $2/share to own them. In fact, it was reported that Chase had bid up to $15/share when competing with Flowers to buy Bear.

I'll add some more thoughts shortly in part two of this post topic.