Bear Stearns Bailout Spurs Fears of Spreading Crisis
Bear Stearns, the fifth largest U.S. investment bank, said a cash crunch forced it to turn to the Federal Reserve and JPMorgan Chase for emergency funds, intensifying fears of a widening global credit crisis and driving its shares down as much as 50 percent.
It was the Federal Reserve's first bailout of a broker since the Great Depression and its latest effort to soothe financial markets roiled by fallout from rising mortgage defaults.
The 28-day emergency line of finance came just days after Bear, which has been hard-hit by its heavy exposure to the faltering U.S. mortgage market, had dismissed market rumors of a cash crunch and said it still was a healthy player in the global web of trading and finance.
But its line changed on Friday. Bear Stearns' chief executive, Alan Schwartz, in a statement explaining how the bank turned to the Fed and a rival bank, said: "Our liquidity position in the last 24 hours had significantly deteriorated.
"We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations."
But inside the bank and on Wall Street, the view was grim.
"The mood is somber," said one Bear Stearns equities salesman who declined to be quoted by name for this story. He said he thought there could be a takeover by Monday. CNBC reported that Bear is already being shopped to JP Morgan and other banks.
Investors, meanwhile, fled. Bear stock plunged on record volume, closing down 45.9 percent at $30.85 and shearing $3 billion off its market value. Earlier, the stock fell as low as $28.42, its lowest price since the 1998 Asian debt crisis.
And Bear debt default insurance surged to a record amid fears for the bank's future, and demand for put options remained strong on bets the stock will fall further.
The news bashed other financial stocks and dragged down both U.S. and European markets.
Though Bear has been one of the hardest hit banks during the credit crisis, it stunned investors by announcing that the Federal Reserve Bank of New York and JPMorgan agreed to provide an unspecified amount of secured funding for up to 28 days.
The Fed will provide non-recourse, back-to-back financing to JPMorgan, which said it is working closely with Bear "on securing permanent financing or other alternatives."
The Fed approved the arrangement in an emergency meeting on Friday morning.
Bear Stearns is often seen as one of the most vulnerable investment banks because it is the smallest of the major New York firms and the most reliant on U.S. mortgage markets.
Growth engines like mortgage-backed securities and complex debt derivatives sputtered to a halt last year.
Bear's reputation as a savvy trader was hurt last summer by the collapse of two mortgage hedge funds, and it suffered losses on its mortgage and credit exposures.
The last straw came this week as deterioration in the markets and the continued struggles of mortgage companies sparked a loss of confidence among traders in Bear.
Schwartz disclosed that the bank's liquidity position "significantly deteriorated" on Thursday, after a series of reports raised questions about Bear's ability to deliver on long-term trades. Schwartz on Wednesday had said the bank had about $17 billion in cash, little changed from Feb. 29.
"At the pace things were going, we recognized it could be that continued liquidity demands would outstrip our liquidity resources," Schwartz said in a statement. "We felt the need to move quickly to conduct normal operations to calm things down and let some facts into the marketplace."
Bear Stearns, JPMorgan and Fed declined to comment. A source briefed on the situation said that without the Fed's intervention Bear would not have had enough cash to open for business Friday.
"I think this is a bridge to a permanent solution," Schwartz said during a conference call with investors. He said the lending facility is sufficient for Bear to fund its daily activities, conduct "business as usual."
Yet he left the door open to pursuing other deals.
"We'll be looking for any strategic alternative that allows us to protect our customers as well as maximize shareholder value, and we'll look at a range of alternatives," he said.
Industry watchers predicted dire consequences for the bank going forward, suggesting that one alternative would probably be a sale.
"I'd say stick a fork in them, they're done," said James Ellman, portfolio manager at Seacliff Capital, a San Francisco-based hedge fund. "The company clearly has to choose from a set of unpalatable choices: sell a large amount of equity, sell the company outright, or sell assets and try to hold on and hope for the best."
Veteran bank analyst Dick Bove, with Punk Ziegel & Co., played down the speculation of an immediate sale, saying such a transaction would not be possible while the Fed is involved.
"The fact of the matter is no one is willing to buy Bear," he said.
It has been a rough honeymoon for Schwartz, a star investment banker who took over as CEO in January, after heavy losses last year prompted James "Jimmy" Cayne to step aside.
Analysts said the news from Bear, which came just one day after investors had been soothed by a Standard & Poor's report that subprime mortgage-related write-downs are likely more than
halfway done, suggested that the full impact of the global credit crisis has yet to be felt.
Indeed S&P on Friday lowered its long-term counterparty credit rating on Bear to "BBB" from "A," and it placed long-and short term ratings on credit watch with negative implications.
"This tells you we're not over the worst yet, and there are still some players out there who are vulnerable," said Stephen Dowds, head of international equities at Northern Trust in London. "We expect more transparency next week when we get results from the U.S. financial sector.
Shares of Lehman Brothers Holdings fell sharply, as did Morgan Stanley and Goldman SachsGroup.
JPMorgan said it does not believe the Bear transaction exposes its shareholders to any material risk. The Fed declined to comment, but it will mirror actions taken by JPMorgan, providing liquidity to Bear indirectly through JPMorgan.