Fed To Price its Bear Stearns Portfolio

The reason JPMorgan Chase & Co didn't want $30 billion of toxic mortgage assets on its books after it took over Bear Stearns may be made clear on Thursday.

The Federal Reserve Bank of New York will report how much those assets are now worth, and many analysts expect it to show a drop in value over the three months the Fed has held the bonds and other securities.

In March, in a highly unusual move, the Fed provided the financing for JPMorgan to acquire Bear Stearns in order to prevent Bear from going bankrupt and potentially dragging down the entire financial system.

Part of that deal was that the Fed would hold the Bear assets.

The value the Fed now places on Bear's portfolio will be one benchmark for how mortgage-backed assets have performed since March, said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida.

"The purpose of this evaluation is what it may mean for other investment banks that have similar collateral.

It raises the question of whether these other institutions have marked their portfolios to the current market level," Sullivan said.

If the portfolio's value were to drop to below about $24 billion, that could indicate mortgage-backed securities have fared even worse in the second quarter than markets have already reflected, analysts said.

Such a poor showing could weigh on shares of banks -- many of which still hold huge portfolios of hard to value mortgage bonds -- and possibly spur safe-haven buying in the U.S. Treasury market.

On Thursday at 4.30 p.m., along with the H.4.1. release on custody holdings and discount window borrowing, the Fed plans to release its decision on the fair value of that portfolio as of June 26.

Given the decline of many sectors of U.S. mortgage-backed securities since then, most analysts expect the $30 billion total to fall.

"It gives an idea on the distressed (assets) in the portfolio.

It will tell us how much the Fed bailed out Bear Stearns and helped out JPMorgan," said Jeff Given, portfolio manager at MFC Global Investment Management in Boston.

"It will give a threshold on the bailout," he added.

"If that portfolio declined more than 20 percent I would imagine that would be pretty negative for (those sectors of fixed income).

It would show the Fed has been bailing out bad investments," said Given.

A red flag for markets would be a drop of the portfolio below $25 billion, said Sullivan, while below about $27 or $28 billion "would seem to suggest that a lot of collateral on the balance sheets of financial services companies is still subject to appreciable write downs," he added.

The Fed has said the portfolio contains collateralized mortgage obligations, most of which are backed by government-sponsored enterprises such as Fannie Mae and Freddie Mac .

It also holds other asset-backed securities -- a sector that includes subprime mortgage bonds -- adjustable-rate mortgages, commercial mortgage-backed securities, and collateralized bond obligations.

Markets for many of these investments have deteriorated further as the outlook for U.S. housing has worsened and investors see banks and hedge funds continuing to unload risky assets from balance sheets.

Regarding non-agency mortgage securities, on average "AAA" rated are between flat in value to down 5 percent since mid-March.

Below "AAA" ones are down anywhere between 10 percent and 30 percent.

The worst ones "you receive a few years worth of coupons but not your principal back," said Given.

Amitabh Arora, managing director, interest rate strategies with Lehman Brothers, New York estimates that overall, U.S. mortgage security prices, already down about 25 percent in the first quarter, have lost another 5 percent since.

"I doubt whether the Fed will use mark-to-market valuation procedures," in assessing the Bear Stearns portfolio's value, Arora added in an email note to Reuters.

"If it shows (the Bear portfolio) has substantially lost value over past 3 months, I think that would lead other investment banks to make similar adjustments," Sullivan said.

Bear Stearns itself gave a $30 billion mark-to-market value for the portfolio as of March 14, when it was the fifth-biggest U.S. investment bank.

JPMorgan Chase & Co. agreed to acquire Bear on March 16 with the Fed's approval.

But exactly how that number was decided remains unclear.

"Who knows how they priced the $30 billion in the first place," said Ray Stone, economist with Stone & McCarthy Research Associates, in Princeton, New Jersey.

"It might have been that the $30 billion was a fire sale price and was marked down severely at that point in time," Stone added.

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