More To Bear Stearns/JP Morgan
Deal Than Meets The Eye
Jim Prevor’s Perishable Pundit, April 11, 2008
Our piece, Lessons For Everyone From Bear Stearns, pointed out that in the collapse of that firm, there were lessons for all businesspeople regarding leverage — both the amount of leverage that can safely be accommodated and the importance of tying the term of the leverage to the assets you intend to hold.
We happened to come across some writing by a sharp young academic at NYU’s Stern School of Business. Our paths crossed because he picked up on an article in the Orange County Register entitled, Tesco’s Fresh & Easy Off to Rocky Start, Industry Watchers Say, in which the Pundit was quoted.
In any case, we thought he had an insight, in a piece entitled, Rescue for Bear or Bailout for JP Morgan, that we hadn’t seen before as an explanation to help us better understand the Bear Stearns/JP Morgan deal:
Much has been written about how JP Morgan was looking to acquire businesses in which Bear was strong (e.g., prime brokerage), and some even maintain that JP Morgan was looking to buy a regional bank.
This may be, but I believe that there is another explanation that has been little explored because, quite frankly, the data that would allow one to gauge this motivation are not publicly available.
Specifically, I believe that JP Morgan acquired Bear because they stood to lose the most from a Bear Stearns bankruptcy. For example, as Barry Ritholtz of the Big Picture points out (see here), JP Morgan has the greatest derivative exposure of any of the I-Banks. Now, I do not know how much of that exposure was to Bear Stearns as the counterparty, but I bet it was a fair amount (in fact, see Jesse’s Cafe Americain for information on Bear’s credit derivative exposure).
If Bear were the counterparty (insurer) to JP Morgan on much of its mortgage-backed security portfolio, it then becomes transparent why JP Morgan had to step in. They would have had to step in to avoid a Bear bankruptcy so that they would not be forced to take toxic assets back onto their own balance sheet and avoid massive write-downs. Were JP’s exposure to Bear large enough, then JP Morgan itself could have been left significantly impaired.
This might also explain the Fed’s interest in Bear. For example, if it were only Bear at risk and their exposure was spread relatively evenly across counterparties such that many of the big, primary banks were not at risk as a result, the Fed would have had no interest in this event. Instead, it would have just let Bear fail. But the Fed could not let Bear bring down JP Morgan with it. So it stepped in to orchestrate an orderly wind-down of Bear while facilitating its acquisition by JP Morgan.
The information is not publicly available to test this thesis, but that doesn’t mean it is wrong, and it is a useful reminder that we often have no choice but to operate but in a state of ignorance.