Bear Stearns: RIP

The big business news this Monday is the acquisition of Bear Stearns by J P Morgan Chase over the weekend. At the close of the market last Friday, Bear Stearns was valued at $30/ share. When the deal was announced on Sunday, Morgan was only paying $2 per share. In addition, the Federal Reserve agreed to loan Morgan $30 billion dollars, taking as collateral mortgage backed bonds in Bear's portfolio. Basically, the Fed (by which I mean the taxpayers) took the bonds most likely to go into default off JP Morgan's hands.

This looks like a steal for JP Morgan. They're paying $2 a share for a company with a book value of $80 a share. Even if it is written down by half, the assets would still be worth 20 times what Morgan is paying for them. The real estate held by Bear Stearns alone is worth about four times the purchase price.

Bear Stearns was one of the five largest US investment banks. The employees owned 30% of the stock. Their stake is now valued at less than $5500 per person. The Chairman of Bear Stearns, John Cayce, was one of the richest Wall Street executives, with holding in BS stock worth oven $1 billion less than a year ago. What could have convinced the management of Bear Stearns to take a deal that essentially wiped them out?

In a word: liquidity.

Liquidity is a measure of how easy it is to convert assets into cash. Cash is always the most liquid asset of all. Normally, stocks are almost as liquid as cash. Call your broker, tell him to sell, and you can have cash within a couple of hours. If you have a store that has inventory, you will usually liquidate the inventory every couple of months. Anyone who has ever tried to sell a house in a down market knows that real estate can be one of the most illiquid forms of asset.

Bear Stearns ran their financial trading operations using a lot of borrowed money. Some of the money was given to the firm by it's clients. Some by other banks. What happened last week was that these parties started to pull their loans from Bear Stearns. In order to keep operations going, Bear Stearns would have had to sell assets from their portfolio. The problem is that right now, no one is buying mortgage backed assets. That market will probably come back in a few months, but Bear Stearns needed money right now.

Basically, the brightest minds in finance became part of a panic driven run on a bank. And a Wall Street titan that survived the Great Depression is no more.