In the fairy tale “Goldilocks and the Three Bears,” Goldilocks seemed happy enough to have a few bites of porridge from Mama, Daddy, and Baby Bear’s bowls. But when Jamie Dimon, the CEO of JPMorgan Chase, visited “The Bear” he took everything in its den.
JPMorgan increased its bid Monday for Bear Stearns to $10.13 per share, up from the original offer of $2 per share. The revised offer values Bear Stearns at about $1.2 billion.
Under the deal, Dimon gets a building worth more than $1.2 billion, a firm that has an earning power of more than $1 billion annually, and a company that some analysts felt enjoyed a book value of over $10 billion.
In addition, the Federal Reserve agreed to cover up to $29 billion of potential Bear Stearns losses.
The sudden meltdown of Bear Stearns, a historically scrappy, very profitable investment bank, shocked almost everybody with the exception of some relentless short sellers. A track team composed of Willie Sutton, Jesse James and John Dillinger could not have made a faster run on the Bear Bank.
In the interest of full disclosure, I am on the board of directors of a Bear Stearns exchange-traded fund (YYY).
Let me give you the back page on why our financial leaders blessed this deal. Since August 2007, both the U.S. Treasury and the Federal Reserve have needed to take very bold steps to arrest the threat to the U.S. and the world economy because of massive problems in our financial sector.
Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke jumped through hoops to prevent the first financial crisis of the 21st century. These leaders might have been influenced by the dire predictions of two economists, Carmen Reinhart and Kenneth Rogoff. They wrote that the impending American recession could rank in severity along with worst recessions of developed countries since World War II.
Reinhart and Rogoff pointed out that starting in the summer of 2007, the United States experienced a striking contraction of wealth, a deterioration in the functioning of the credit market, and a demand by lenders for significantly higher premiums.
These economists pointed out that in comparison to the other countries that slogged their way through tough recessions, the United States had a greater housing price run-up, a larger current account deficit and a relatively high combination of public and private debt load.
Defenders of “The Bear Hug” point out that the government’s promise of a multi-billion loan averted the fall of other financial dominoes.
We should note that the financial sector has become our most important industry. At the end of 2007, although the financial sector employed about 5 percent of the American work force, it represented close to 40 percent of aggregate corporate profits.
Of course, to achieve this high level of profitability the financial community took such great risks with their balance sheets that when the music stopped they either failed or needed bail-out funds to survive. Since the financial community is linked so tightly, the Federal Reserve and Treasury needed to contain the virus.
Finance rose to the top of the slippery pole for several reasons.
First of all, over the past 30 years, investment banks and commercial banks have benefited from an enormous growth from new product lines such as the trading of derivatives, the evolution of junk bonds and the willingness of financial houses to leverage recklessly their balance sheets to obtain enormous trading profits.
Secondly, while the financial sector was growing, much of our manufacturing sectors such as steel, automobiles and textiles was rusting away.
Thirdly, there was the quantum growth of hedge funds — risky investment pools that take outsized risks for outsized rewards.
Finally, the growth of the financial sector was facilitated by deregulation. In this benign — or malign — neglect environment, investment banks and mortgage bankers operated with much less regulation and margin requirements than commercial banks. Borrowing heavily is a two-way street — big wins and colossal losses. A few days prior to the meltdown, creditors pulled out $17 billion from Bear Stearns, forcing an urgent “for help” call to Washington.
Alas, when I think of the demise of Bear Stearns, I am reminded of the prophetic warnings of my former boss, the late Lewis Glucksman, former president of Lehman Brothers. Lew ruefully warned: “when they raid the whorehouse, they take all the girls!”
Originally published in the Sarasota Herald-Tribune
