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Ask YC: Can someone explain this JP Morgan buyout of Bear Stearns for me?

• aristus 19y ago
  Somebody set us up the moneybomb! All your basis points are belong to us. Bear is an investment bank, and does not have direct access to borrow money from the Fed. Lat week JP agreed to act as a kind of conduit for loans backed by some of Bear's more toxic assets. Sounds stinky, eh? The thing is that the Fed and everyone else is scared stiff that Bear would default. That would set of a ricochet all through the banking and trading system. This buyout is actually the lesser of two evils, and the price is so low because no one really knows what liabilities and losses are to come.
  • mk 19y ago
    Let me get this straight. JP is taking a loan from the Fed to buy Bear?
    • aristus 19y ago
      Yes & No. JP is buying Bear with its own cash. It's only $230-odd million. The Fed allowed an unusual transaction in which $30B of Bear's toxic assets were put up as collateral for Fed loans in order to keep its (Bear's) operations and trades going. The Fed took some of the pressure off of Bear's balance sheet to make it more attractive to JP and reduce the damage to JP's balance sheet once the entities merge. Bear: "Mein Leiben!" Fed: "Holy sh*t, this can't happen! You, JP! You hold a lot of Bear's paper already. We need your help, and we'll sweeten the deal, ok?" JP: "I'm gonna make you an offer you can't possibly refuse..."
    • aneesh 19y ago
      No loan, but if things go badly and JP can't back Bear's bad loans, the Fed has got their back.
  • dpapathanasiou 19y ago
    Bear is an investment bank, and does not have direct access to borrow money from the Fed. Ah, but under "emergency measures" announced today by the Fed, securities dealers (for at least the next six months, anyway) may borrow from the Fed on much the same terms as banks.
    • mixmax 19y ago
      Unfortunately for Bear these emergency mearures were only enacted today, and Bear needed the money on friday. Lousy timing...
      • dpapathanasiou 19y ago
        Well, the sale to JPM was probably already a done deal at that point. It seems these measures are because there are probably other Bears out there, but not enough JPMs to save them all.
        • mixmax 19y ago
          I'm pretty sure that the sale wasn't a done deal on friday. The problem didn't get serious until friday morning, and thursday I think that nobody even suspected a firesale. Unrelated: what does your username mean? Is it a greek last name, something else, or just a random sequence of letters? Just curious...
          • dpapathanasiou 19y ago
            I'm pretty sure that the sale wasn't a done deal on friday. The problem didn't get serious until friday morning, and thursday I think that nobody even suspected a firesale. Take a look at this timeline: http://online.wsj.com/article/SB120580966534444395.html?mod=hps_us_inside_today http://online.wsj.com/article/SB120580966534444395.html?mod=... Unrelated: what does your username mean? Is it a greek last name, something else, or just a random sequence of letters? Just curious... It's my first initial and last name (which, yes, is of Greek origin). Any more questions, Mr. Ixmax? ;)
  • ctkrohn 19y ago
    "All your basis points are belong to us." Pure genius. I will have to put this in my Bloomberg header.
• jey 19y ago
  There's great discussion about this in this thread if you haven't seen it: http://news.ycombinator.com/item?id=138508 http://news.ycombinator.com/item?id=138508
• noodle 19y ago
  i think this is a pretty good explanation: http://www.portfolio.com/news-markets/top-5/2008/03/14/The-Bear-Facts http://www.portfolio.com/news-markets/top-5/2008/03/14/The-B...
• dpapathanasiou 19y ago
  Bear Sterns did not have enough liquid capital to distribute to investors seeking to withdraw their money, a bank run Bear couldn't cover their margin calls (http://en.wikipedia.org/wiki/Margin_call#Margin_call http://en.wikipedia.org/wiki/Margin_call#Margin_call). And now the Fed has helped or guaranteed those investments so that JP Morgan can buy them for $2 a share. JPM wasn't going to touch Bear's liabilities without some guarantees from the Fed. Details of the plan haven't been released, but here's a pertinent quote from the Journal (http://online.wsj.com/article/SB120569598608739825.html?mod=special_coverage http://online.wsj.com/article/SB120569598608739825.html?mod=...): To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns's less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn't describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan. Note that last sentence means the U.S. government (i.e., ultimately every taxpayer) is on the hook for that $30 billion.
• aswanson 19y ago
  Investment tip: Never, ever put money in a fund with the word 'Gaussian' in it.
• iamelgringo 19y ago
  In a nutshell, banks work like this: People give them money to hold by putting it into checking/savings accounts. Banks then turn around and lend that money to others via loans. Sometimes they use that money to invest for themselves. A bank’s primary asset is trust. For a bank to work, the consumers must believe that their money is safe with their bank. Otherwise, they will not give their own money to the bank for safekeeping, and the bank would have no money to lend to others or invest. The irony is that banks cannot possibly have the cash on hand to give back to all their customers at once. But, as long as people believe in the bank, and keep their money in the bank, the bank stays afloat. The problem that we're having now, is that certain banks that lent out a lot of customer’s money in bad mortgages. So, with as many foreclosures that we’ve had, banks have lost a lot of money, and people lose trust in their banks. When people lose trust in a bank, they withdraw their money, creating a “run on the bank” just like in It’s a Wonderful Life. This is what happened to Bair. The big fear is fear itself. Worst case scenario is that the entire nation would have a loss of trust in the entire banking system. This could cause a run on the banking system, and lead to a chain reaction of banks imploding. This is what happened during the Great Depression. That’s why the Fed stepped in, and said that they would cover Bair’s bad debts to avoid a big bank’s collapse. It sucks, because the rest of the country is on the hook for Bair’s losses. And, the US dollar is gets weaker when the government prints money to cover bad debts. But, it beats a chain reaction of banks imploding.
• TrevorJ 19y ago
  The biggest potential impact on the taxpayer in the extreme short term won't have as much to do with the complete truth of the situation as it will with how the public and the markets interpret the move.
• stevengg 19y ago
  The Money Masters is a good watch if you have time http://video.google.ca/videoplay?docid=-515319560256183936&q=the+money+masters&total=514&start=0&num=10&so=0&type=search&plindex=0 http://video.google.ca/videoplay?docid=-515319560256183936&#...
• brentr 19y ago
  I used to work in the industry, so I will take a stab at explaining this: Bear was overleveraged. The summer of 2007 saw the failure of two internal hedge funds at the company, a confidence crusher. As 2007 wrapped up, the subprime issue spread to other credit markets, effectively freezing the financial system. Bear found it more and more difficult to obtain short-term funding to cover their existing debt that was coming due. Last week, the CEO came on CNBC and stated that there was no liquidity problem at that time. I don't doubt that statement. Then came Thursday morning. A fund at the Carlyle Group failed, and Bear had a lot of business with the Carlyle group. It was the failure at Carlyle that finally TKOd Bear, but it was only a matter of time before it did indeed happen. Now, had Bear declared bankruptcy, which they would have had it not been for JP Morgan, a panic none of us have seen in our lifetime would have ensued. Bear would have been forced to dump all of its assets on the market, even the ones that Wall Street doesn't even know how to price. A complete breakdown of the US financial system would have ensued, and there would have likely been a run on not just an investment bank, but a retail bank as well. The Federal Reserve is not in the business of bailing out companies that mismanage their businesses, but they are in the business of maintaining an orderly market (in addition to their mandate to control the money supply). When Bear went to the Fed on Friday, the Fed knew they'd have to find someone willing to take Bear. JP Morgan was the company best situated to buy Bear; JP Morgan had the capital and was looking for a prime brokerage division and better clearing operations. While Bear provided both of those, there is a large set of unknowns on Bear's balance sheet, and had the Fed not offered to cover up to $30 billion of the more illiquid assets, the deal would have fallen through. Part of the taxes you pay will be used to eat any losses the Fed takes.
  • projectileboy 19y ago
    Excellent summary. Thanks!
• symptic 19y ago
  This instance reminds me of a video I saw a while back, 'Money As Debt'. http://video.google.ca/videoplay?docid=-9050474362583451279&q=money+as+debt&total=4017&start=0&num=10&so=0&type=search&plindex=0 http://video.google.ca/videoplay?docid=-9050474362583451279&...
• xg 19y ago
  Other people did a good job explaining the basics. The issue is about book value and the complexity of the risk. The risk is similar to what the firm Citadel did with E*Trade. The risk on the books of Bear Stearns can't be fully calculated and JP Morgan is assuming that risk, hence the low price. The Fed is possibly going to limit the downside risk of JP Morgan to keep stability in US financial markets, though they are not putting up any additional capital upfront. Roger Ehrenberg has some great blog posts on the topic (he used to run a big hedgefund and now has an NYC startup called Monitor110): http://www.informationarbitrage.com/2008/03/the-bear-facts.html http://www.informationarbitrage.com/2008/03/the-bear-facts.h... http://www.informationarbitrage.com/2008/03/i-bear-ly-knew.html http://www.informationarbitrage.com/2008/03/i-bear-ly-knew.h...
• jellicle 19y ago
  Let me see if I can sum it up in small words. Bear Stearns bought a lot of mortgage-backed securities over the past couple of years. These securities are currently worthless - no one will purchase them at any price. Bear Stearns has debts, but no assets = bankrupt. JP Morgan sought to buy Bear Stearns, but is unsure just how much of Bear Stearns' portfolio is worthless, so they're not sure how much they'd be willing to pay. So they got a bailout from the Federal Reserve. The Federal Reserve agreed to 'loan' $30 billion to Bear Stearns, secured only by - this is important - utterly worthless mortgage securities. This means that if BS doesn't pay the money back, the Federal Reserve can ONLY take those worthless securities and can't come after any other assets of BS or JPM. In other words...... it's free money. (If I loaned you $10,000 using a single toothpick as collateral and agreed that if you didn't pay it back, I could only keep the toothpick and couldn't go after any other assets you may have, that would be a gift, right? Would you pay back the money and get your toothpick back, or keep the money?) BS will never pay back the $30 billion. It's a free gift from taxpayers to the financial industry. Even with the free gift, JPM still didn't deem BS to be worth very much. Indeed, sinec BS's office building is worth $1 billion and JPM paid $236 million for all of BS including the office building, JPM forecasts that after the $30 billion gift, BS is worth about negative $750 million or so.