Extra! What the Bear Stearns Bailout Means

03/18/2008 12:00 am EST

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Howard Gold

Founder & President, GoldenEgg Investing

Is JP Morgan Chase buying a pig in a poke? Or is its purchase of beleaguered investment firm Bear Stearns the steal of the century?

We won't know for a while, but I'd guess in a year or two JP Morgan's chief executive officer Jamie Dimon will look like Willie Sutton-metaphorically, of course.

By buying Bear for a mere $2 a share, or around $240 million (based on Friday's closing price), JP Morgan (NYSE: JPM) is paying less than a quarter of the estimated value of the investment firm's midtown Manhattan skyscraper, which may now become the new owner's new headquarters. 

Dimon also is getting Bear's long-coveted prime brokerage business (which does business with hedge funds), its asset management business, and its securities operations.

Not that this deal is risk-free: JP Morgan may have to shell out as much as $6 billion in severance costs, legal liabilities, and other unforeseen expenses. Hungry lawyers are gathering like jackals to feed at Bear's carcass.

But Sanford Bernstein analyst Brad Hintz estimates Bear's breakup value at $7.7 billion, or a little less than $60 a share. (The stock hit an all-time high near $170 last January.)

And the Federal Reserve will guarantee up to $30 billion to cover unexpected explosions in the minefield that Bear's portfolio has become. To go through that would probably mean Bear's mortgages and mortgage-backed securities are worthless, which they're not. So, although there are risks, it's hard to see how Dimon will lose on this deal-if Bear's angry shareholders ultimately agree, of course.

The buyout, engineered by the Fed in collaboration with the US Treasury Department, came over a frenetic, sleepless weekend that followed a classic run on the bank last week, as panicky clients yanked their business from the reeling New York firm. JP Morgan, with the Fed's backing, was the only real alternative to bankruptcy.

Fed Chairman Ben Bernanke, once dubbed "Behind the Curve Ben" by his many Wall Street detractors, has done everything  from aggressively cutting interest rates to pumping billions and billions of dollars into the system to allowing financial institutions to offer the worst junk as collateral at the Fed's borrowing windows. If he could, I'm sure he'd even pick up a pail and shovel water over the side of this boat to keep it from becoming the Titanic.

Fear and panic are sweeping Wall Street as worries grow that the federal government will have to launch a system-wide rescue effort of investment banks similar to the early 1990s when the Resolution Trust Corp. took over the assets of failed savings and loans and auctioned them off at fire-sale prices.

But although I've been wrong about this before, I don't think the contagion will spread to other firms. Lehman Brothers Holdings (NYSE: LEH), rumored to be the next domino to fall, is bigger and more diversified than Bear was. Both it and Goldman Sachs Group (NYSE: GS) reported better-than-expected earnings on Tuesday, triggering a big rally on Wall Street.

As I'm writing this, Goldman is trading at nearly $170, up over 20% from its lows on Monday, while Lehman changes hands at almost $43, more than double its panic low of $20 yesterday.

Is this the bottom in financial stocks? Beats me, but if there are no more big blowups a la Bear Stearns, then Monday may eventually be seen as the capitulation that precedes a big turnaround. (Both the Dow Jones Industrial Average and the Standard & Poor's 500 also may have successfully retested intraday lows on Monday-11,600 for the Dow and 1270 for the S&P.)

The biggest losers in this, of course, are the 14,000 employees of Bear Stearns, many of whom will face unemployment and the overnight evaporation of much of their net worth. The firm was one-third owned by the employees, whose shares were once valued at over $6 billion and now are worth a fraction of that.

I'm very sympathetic with the secretaries, back-office personnel, support staff, and worker bees who toiled long hours for their firm and their clients over many faithful years. Too many of them will see their dreams of financial security and a comfortable retirement go up in smoke, through no fault of their own. Many pension funds and individual investors who owned Bear Stearns also will feel the pain.

But I have no sympathy whatsoever for the reckless, greedy adventurers who ran Bear Stearns into the ground and, together with their counterparts at the other major Wall Street firms, have brought an otherwise strong economy to the brink of catastrophe.

Future litigation and widely reported criminal investigations may eventually show us how bad some of these people really were. Maybe then we'll see some of the justified outrage that I find almost entirely absent from major media outlets, who seem as shell-shocked as ordinary investors and may be a little too close to their Wall Street sources.

Bear Stearns was known to be a take-no-prisoners outlet. Its former chief executive officer Alan "Ace" Greenberg famously dismissed the 1987 stock market crash with the curt remark, "Stocks fluctuate, next question."

And in 1998, Bear refused to participate in the bailout of Long-Term Capital Management engineered by the New York Fed, which may have saved the markets from another crash.

Chairman and former CEO James Cayne, who was busy playing bridge when Bear Stearns faced a crisis last summer, again reportedly fiddled while Bear burned this time around.

And, get this: in late December, nine top executives and directors sold nearly $50 million worth of Bear stock, mostly through exercising options, at around $89 a share. They included Cayne, Greenberg, current CEO Alan Schwartz, and chief financial officer Samuel Molinaro, according to Yahoo Finance. Good timing, guys.

The only good news here is that these same people who got their firm and the rest of us in so much trouble have seen the value of their remaining holdings plummet.

Live by the sword, die by the sword.

Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his alone and do not necessarily reflect the views of InterShow.

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