Monday, March 17, 2008

The Precipice

There is a lot about the Bear Stearns bailout story we don't yet know, so I don't have too much to say about it. Obviously the $2/share price tag is the scariest part. Anyway, I thought I'd throw out some stuff from my markets that you might not see elsewhere.

  • Clearly if Bear Stearns was only worth $2/share, then Lehman and the other brokers are worth far less than what they were worth on Friday. And that doesn't have anything to do with their actual assets or liabilities, but that if someone else needs a bailout, its going to look similar to the JPM/BSC deal. So even if you assume that the odds of another firm needing a bailout are relatively low (say 10%), that's a 10% chance that the firm is worth essentially zero.
  • Why the hell is Bear stock trading at $4?!? Now I'll admit that there is a chance that another buyer would have paid more for BSC. But I can't imagine another buyer emerging now. By all accounts, the Fed orchestrated this from start to finish. I mean, J.C. Flowers was a bidder, but would the Fed want J.C. Flowers to have bought Bear? Hell no. J.P. Morgan was one of just a handful of financial institutions in the world that would bring unquestioned stability to Bear's balance sheet. Once the Fed got JPM involved, the Fed wasn't going to let anyone other than JPM to finish the deal.
  • As I'm writing this, the Dow is down 20 and the S&P is only down 10. Nothing, nothing, would surprise me today. Down 500? Up 200? Who knows? What we have is a tug of war. Traders betting on things getting worse. The Fed and Treasury are trying to draw a line in the sand, telling the market they won't let either banks nor primary dealers fail as long as they still have decent assets to pledge as collateral. The Traders have momentum on their side, the Fed has gigantic piles of cash on their side.
  • Speaking of the Fed's weapons, someday when we really know everything about what really happened at Bear Stearns, it will be interesting to see whether Bear would have survived if they had access to the discount window and/or the TSLF. In other words, had the Fed acted quicker to extend liquidity to dealers, would be have been better off?
  • Spreads on interest rate swaps, which is viewed as a broad measure of counter-party risk, are substantially tighter today, about -5bps on 10-year swaps and -7 on 2-year swaps. Doesn't sound like much, but that's a pretty big move for swaps.
  • Freddie Mac and Fannie Mae debt spreads are also tighter, but only by 1-2bps.
  • Agency MBS are performing in-line with Treasuries. That's encouraging, as MBS rarely keep up with Treasuries when rates are falling.
  • Credit spreads are definitively wider, but I'm hearing there is little conviction either way in cash bonds. I will say that I wouldn't be a buyer of protection against any of the big banks or brokerages here. The Fed just delivered a big middle finger to people who bet against Bear Stearns. If you want to bet against brokerages, the stock is a much smarter bet. The Fed doesn't give a fuck if a stock falls 50%. They have basically unlimited power to prevent a bankruptcy.
  • Moody's affirmed Lehman's A1 rating this morning, after Lehman secured a $3 billion credit line on Friday. This doesn't mean very much, even forgetting the ratings agencies recent poor record on rating mortgage deals. The problems brokerages are facing today have nothing to do with the normal financial ratio-type analysis that the ratings agencies do. In fact, for a guy like me who likes to pour over financial statements when making an investment decision, analyzing credits now is next to impossible.
  • Lehman and Goldman's earnings reports tomorrow are probably the most important earnings reports for the broad economy of my career.
  • We're going to get 100bps tomorrow.

Good luck to Bear Stearns employees.


aa said...

There is arbitrage pressure now - as JPM stock goes higher, BSC gets dragged along as well.

2and20 said...

Why the hell is Bear stock trading at $4?!

if i was that joe lewis guy who just dropped $1bn on bear, i'd be spending another couple of hundred million buying as much bear stock as i could.

if you can get enough stock to vote against jp taking it over, you are then holding the fed to ransom, if you are prepared to lose your investment. pay $4, demand $30/50/80 a share whatever, and see what you can squeeze out of them. for the fed/jp, it's a choice of spending another few billion or letting BS go bust. you never know...maybe someone could just about pull that off!

Walt French said...

Spreads on interest rate swaps... are substantially tighter today

Deep out-of-the-money Fed puts just went up in value. Higher volatility, I guess, since the strike is about where it was before.

Anonymous said...

What if JPM never takes over BSC in the end? BSC has 28 days to get their ship together, deleverage, and then the deal just falls apart. JPM gets some assets to walk away. Someone could have bought most of the company today at 4.00. in the open market.

Anonymous said...

JPM is putting up a charge of $6b or $50/share for Transition expenses, including litigation. If they could use $1 b to settle everything, that would be another $8/share. I don't think it will happen that way, but why not pay the shareholders then the class action lawyers.

Anonymous said...

Why $2 then and not something a little higher? A reporter asked Paulson today when he was going to 'bail out' the little guy, the homeowner. Paulson made it a big point that Bear management got wiped out.

Why not $0? This keeps it from being a 'credit event' and CDS's on BSC debt don't pay off. I would love to know who had what riding on a default.

I'm also dying to know what the 'conforming accounting', mentioned as part of the transition costs, refers to. Maybe Bear or JPM have transactions with each other that don't net to zero.