A Brief Update on Bear Stearns

A few posts ago, in reference to Wall Street nemesis ex-Governor Elliot Spitzer, I scored his fall from grace as: Masters of the Universe 1; Caped Crusader 0. This evening, the Masters of the Universe lost a point.

The collapse of Bear Stearns does not bode well for the rest of the market. As I understand the news, JP Morgan, Chase & Company have bought Bear for $2.00/share. At this point, I would imagine the shareholder base consists of three types of people: long term investors hoping to ride out the storm, partners of the firm, and a few who believed financial institutions had "bottomed out" and bought in at roughly the closing trading price on Friday, $30/share.

So, if you were in the latter category, which would be the best of the three groups, your losses would be only 1500%. If you bought in around Bear's high last year of approximately $160/share, your loss would be 8000%.

The buy-out price of $257M or so is for Bear itself. The Fed has promised JP Morgan & Chase to cover losses they may incur in assuming the Bear portfolio - i.e. the specific investments made for its clients, as well as help JP fund the buy, up to a total of $30B of our money...don't worry, they'll just add it to the national debt.

Since the Fed is the lender of last resort, one may assume some valuation of the Bear holdings had been completed prior to going to the Fed and that the holdings were found to be mostly worthless junk. That means JP Morgan will be calling on a substantial portion of the promised $30B. Bear was perhaps the investment bank most heavily into the subprime mortgage securitized debt instruments. Another bank heavily invested in the same is USB, United Bank of Switzerland. Expect them to take a heavy hit on Monday and be in a "touch and go" situation for the next few weeks.

The Bear failure brings up the question of who - if anyone - is next? Is this the beginning of a domino effect? The market may answer that question in the coming week. Some degree of unrest and uncertainty is highly probable, despite the Fed's eagerness to further reduce short term interest rates, beyond the additional quarter of a point they gave up with the Bear news today.

As I pointed out in the earlier post on Bear, my guess is that the banks are in the Phase II process of "revaluing" bad investments. That, coupled with an analyst prediction, I've read somewhere, that said we are only about half-way through the subprime mess, tells me that whereas Bear's demise may be the first, it won't be the last. A whole lot of over leverage and lousy management. Apparently, a few Wall Street CEO's made mistakes similar to those home mortgage borrowers who felt "things can only get better" when they signed up to ARM's.

I have a gut feeling, with nothing really to base it on, that we may see 2-3 additional bank failures; possibly one larger than Bear and one or two smaller failures. If that is the worse case then we may get through this with a recession lasting one-two years, before the house of cards gets repaired and re-building begins. If worse, however, then the underlying problems of the American economy are going to be exposed and the recession could conceivably go into depression, requiring 10 years for recovery...and a generation of very, very nervous and angry, but humbled people.

My preference is that we endure as mild a recession as possible, but take this as a warning of worse to come unless fundamental economic changes are made. The unfortunate thing is that a mild recession may not force policy makers to make the basic changes necessary (if I am right in my theory on the negative effects of globalization on the American economy).

Those necessary changes are what I am building up to in the New Economy posts, but a "preview" of those changes is: a step back from globalization and taking a more selective approach, while pulling back some of the jobs lost overseas, and creating a national economic policy that aims at a "Self-Sustaining National Economy," while not abandoning the longer term benefits of a global economy.

I don't think McCain can go there, given the constraints of Republican economic policies. Neither will Clinton, given the restraints of Wall Street. But, at the moment, Obama (from that great windy city in the mid-west) is still in a position to do so. He is new enough not to be a prisoner of his financial backers and ill-defined enough to still put forward significant changes in his platform.
Will he have the courage? Time will tell...and it will have to be sooner than later.

P.S. After all of this is over and the losses are totaled, I hope someone compares those losses to the amount of money involved in the Bush tax cuts.