Opening Bell: Bear Meat

Helicopter Ben strikes again; is Lehman next? Merrill?; more evidence of subprime greed; etc.

Bear Stearns collapsed into the arms of JP Morgan Chase (and the Federal Reserve) last night, ending the stunningly fast fall of one of Wall Street’s legendary names. The credit crisis just got its biggest victim and its biggest story—so far.

The papers go big on their front pages today with the historic news that JP Morgan agreed to buy the eighty-year-old old investment bank for $2 a share, or $236 million. That’s 99 percent below its 2007 high of $171.51.

The Wall Street Journal doesn’t quite bust out the war font but splashes the story across four columns above the fold on page one, pairing it with the news that the Fed announced one of the biggest lending expansions since the Great Depression. The WSJ says Bear Stearns faced the “horrible” choice to sell now or fold up shop. It devotes its entire Money & Investing front to stories about the fallout.

The Financial Times splays the news across five columns on page one, saying the government wanted a deal done before markets opened in Asia late Sunday night U.S. time to prevent further runs on banks on Europe and the U.S. Asian stocks plunged more than 4 percent.

Bloomberg’s strong story

Bloomberg gets the tone just right in its story, giving readers a sense of the urgency and the peril that lies ahead:

“For Bear’s stock price to go to effectively zero, contrary to market expectations, even at the close on Friday, tells us that something is systemically very wrong and we’re at a very dangerous moment,” Goldman said.

Bloomberg says the Bear debacle implies that Wall Street’s shares are priced too high. It notes clients yanked $17 billion in two days in the panic and flat out states that the Fed’s major moves last week were a failed attempt to save Bear Stearns.

The New York Times calls it “shocking” and “a watershed” and notes that the sale price is less than one-third what the company was valued at when it went public in 1985:

The deal for Bear, done at the behest of the Fed and the Treasury Department, punctuates the stunning downfall of one of Wall Street’s biggest and most storied firms. Bear had weathered the vagaries of the markets for 85 years, surviving the Depression and a dozen recessions only to meet its end in the rapidly unfolding credit crisis now afflicting the American economy.

A throwback to a bygone era, Bear Stearns still operated as a cigar-chomping, suspender-wearing culture where taking risks was rewarded. It was a firm that was never considered truly white-shoe, an outsider that defied its mainstream rivals.

We’re in uncharted territory when the Fed gets involved in mergers and acquisitions: taxpayers will be financing (taking on all the downside risk) $30 billion of Bear Stearns’ junk assets so JP Morgan won’t get caught up in the downward spiral of falling asset prices and margin calls—essentially a run on the bank by Bear Stearns’ banks.

WSJ: Biggest-ever Fed advance

The WSJ says it thinks it’s “the largest Fed advance on record to a single company.” The Fed worries that without somebody guaranteeing Bear Stearns’ so-called counterparty risk—its commitments to other investors and institutions—the ongoing collapse of the financial system would accelerate

As far as government bailouts go, this one could be worse. We’re glad to see the government did not bailout Bear Stearns shareholders, who are already issuing “howls of protests,” the WSJ reports. The paper quotes one employee (Bear Stearns’ employees own one-third of the firm’s shares) who doesn’t get it:

“I’ve got to think we can get more in a liquidation, I’m not selling my shares, this price is dramatically less than the book value Alan Schwartz told us the company is worth,” said a midlevel Bear Stearns executive. “The building is worth $8 a share.”

The building may be worth $8 a share but the rest of the company is worth negative dollars a share, dude.

Shareholders have been essentially wiped out, as they should be, to prevent what economists call “moral hazard,” in this case the implication that the government will bail Wall Street out of its own mess because it’s “too big to fail.”

Not many on Wall Street‐or in the real world— are going to mourn the demise of Bear Stearns. It couldn’t have happened to a nicer company: the dithering chairman and ex-CEO Jimmy Cayne, who true-to-form was in Detroit playing bridge while it was dominoes that should have had his attention. The lying CEO Alan Schwartz who told investors all last week that everything was just fine. The in-it-for-itself ethos that offended even Wall Street. Its aggressive subprime-mortgage business and its past ties to businesses it knew were shady.

Low-rate raters

Here’s this nugget about the credit-ratings firms, who still can’t find a nut:

Late Friday, credit-ratings firms downgraded Bear Stearns to two or three levels above junk status. The downgrades also had a big impact on Bear Stearns’s viability, as they severely crimped the firm’s number of potential trading partners.

Let’s see, a company that’s for all intents and purposes insolvent still merited an investment-grade debt rating on Friday?

But what is essentially the bankruptcy of a Wall Street titan, which the Journal ceaselessly reminds us was one of the most-respected at managing risk, will shake markets to their core. Even on Friday, when Bear Stearns announced it required a Fed-backed cash infusion, it ended the day worth $30 a share, or $3.5 billion.

So what are we in for? It’s impossible to tell, but watch for stock markets to gyrate wildly in the coming days and weeks as the shock is digested. This crisis began in earnest with news of the implosion of two Bear Stearns hedge funds last June, now it seems as if the U.S. itself is an imploding hedge fund (a comparison that’s not so out of line given how debt-laden it is and how much risk it has taken on in the last decade).

Investors might like to think this is a bookend to the disaster, but it’s only going to get worse from here. We haven’t really had one of those truly stomach-churning stock-market freefalls in this crisis, but we will. The Dow Jones Industrial Average is still (!) not in bear-market territory, meaning it hasn’t dropped 20 percent from its peak.

The FT says it’s going to be grim with Goldman Sachs and Lehman Brothers due to report earnings this week that are likely to be losses. And the WSJ on A1 says the big banks think this mess is going to last well into 2009.

“The most pressing question on investors’ minds: who’s next?” said Jeffrey Rosenberg, head of credit strategy at Banc of America Securities. Analysts expect US banks to report some $50bn in additional losses in the first half of this year—in addition to the $100bn-plus in writedowns announced so far—as key markets such as leveraged loans, home equity and real estate continued to deteriorate.

Throw money at it

In an unprecedented move coinciding with its deal with JP Morgan to buy what’s left of Bear Stearns, the Federal Reserve—again—dropped cash from the proverbial helicopter to try to ease a crisis that is less about access to cash than about the fundamental insolvency (or fear of insolvency) of major financial institutions in the U.S. and Europe. The Fed will now lend money not just to banks, but to brokers, as well—just a tad late for Bear Stearns.

Two of the papers and Bloomberg get the import of the news just right in their page-one ledes. The NYT says the Fed is “Hoping to avoid a systemic meltdown in financial markets,” while the WSJ says the move is “one of the broadest expansions of its lending authority since the 1930s in an effort to stem a credit crisis that is engulfing the financial system and threatening a deep recession. ” Bloomberg says “The Federal Reserve, struggling to prevent a meltdown in financial markets, cut the rate on direct loans to banks and became lender of last resort to the biggest dealers in U.S. government bonds.”

The Fed cut one of its lending rates by a quarter-point and the Journal’s Fed-mole Greg Ip says it “is expected” to cut the federal-funds rate charged for loans overnight between banks by up to 0.75 percent.

The historic nature of the steps the Fed has taken reflects what the central bank sees as the unprecedented scale of the storm now sweeping through the markets and the economy. Starting with rising defaults on subprime mortgages a year ago, the crisis now has caused investors to question the ability of once rock-solid firms to repay loans.

That has triggered a massive deleveraging. Investors, banks and others are hoarding cash, pulling in their loans and trying to reduce their own exposure to risky markets. That has sent yields on risky securities such as mortgage-backed bonds up, dealing the housing market and the economy a fresh blow and leaving the Fed seemingly powerless to restore a willingness to lend by cutting interest rates, its traditional tool…

The NYT says that like the Fed’s $200 billion program unveiled last week, the new one that lends to Wall Street will take the junk securities nobody wants as collateral. That essentially means taxpayers are taking some big ones for the team by taking on those mortgage-backed securities that are unlikely to be in more demand any time soon, if ever.

Who’s next?

Now the eyes of investors and the world turn who might be the next Wall Street (or European investment banking) firm to fall. Odds are on Lehman Brothers.

Reuters says Lehman’s shares “have been battered by fears it may face liquidity issues similar to Bear Stearns” and the wire service reported Saturday that it has lots of exposure to mortgages and that some investors are pulling their money back from the bank.

Here’s BusinessWeek:

But Lehman Brothers Holdings Inc. appears to be an investment bank that investors are very worried about right now—mainly because it is the investment bank that is most similar to Bear in structure and exposure. Its stock dropped more than 14 percent on Friday.

Banks gave Lehman a vote of confidence of sorts, however, on Friday—Lehman Brothers said its new credit facility was “substantially oversubscribed,” and that some of world’s largest banks participated.

The NYT says Merrill is also being watched.

Indeed, investors are taking a grim view of the prospects for other investment banks like Lehman Brothers and Merrill Lynch. Managers of hedge funds and mutual funds say the problems at Bear confirmed their worst fears about the brokerages — that they have relied too much on leverage and have done a poor job managing the risks they took on during the boom…

And while Bear’s peers on Wall Street are not yet in such dire shape, they have surely accepted the reality of leaner times and lower valuations in the months to come.

Here’s our Quote of the Day, from the NYT:

“Banks and brokerages are a house of cards built on the confidence of clients, creditors and counterparties,” Mr. Trone said. “If you take chunks out of that confidence, things can go awry pretty quickly. It could happen to any one of the brokers.”

Who, us worry?

In non-Bear Stearns news, but going back to what triggered it all, the Los Angeles Times reports more on the story of how subprime lenders ignored warnings from people they paid in order to churn out more dodgy loans. This is a solid piece of reporting.

They could see the meltdown coming.

Freelance financial watchdogs who examined the paperwork on sub-prime home loans being sold to Wall Street had an inside view of the boom in easy-money lending this decade. The reviewers say they raised plenty of red flags about flaws so serious that mortgages should have been rejected outright—such as borrowers’ incomes that seemed inflated or documents that looked fake—but the problems were glossed over, ignored or stricken from reports.

The loan reviewers’ role was just one of several safeguards—including home appraisals, lending standards and ratings on mortgage-backed bonds—that were built into the country’s complex mortgage-financing system. But in the chain of brokers, lenders and investment banks that transformed mortgages into securities sold worldwide, no one seemed to care about loans that looked bad from the start. Yet profit abounded&mdas;huntil defaults spawned hundreds of billions of dollars in losses on mortgage-backed securities.

Bringing it all back home.

Bullied buck

In economic news, the Fed’s moves and concerns about the solvency of American institutions sent the dollar tumbling again, this time to a thirteen-year low against the yen and a record low against the euro. Bloomberg reports some investors say Bernanke has triggered a “vicious circle of doom for the dollar.”

Gold jumped by 3 percent and crude oil was up nearly 2 percent on the inflation-inducing Fed policies.

Bloomberg says the cost of insuring corporate debt soared more than 15 percent overnight in Japan.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.