The Bear Stearns Poster Boy Walks

Writing about Bear, Stearns a few months back, I said that:

If there is a central villain in the piece, I suppose it is Ralph Cioffi, who structured the hedge funds that loaded up on subprime--the collapse of which funds led to the ultimate collapse of the firm. Cioffi ...appears to bear all the earmarks of a good salesman: insane optimism, poor impulse control, and a knack for manipulation.

Link. Well, maybe. But at least I did not add "and obviously a felon." A jury in Brooklyn has acquitted Cioffii (and a colleague) of all charges, and apparently it wasn't even close. Per Bloomberg, a juror said that the government's case was "so weak she'd invest with defendants" (link). The jury spent a month hearing testimony and took just nine hours to set them free. Evidently being a good salesman is not a crime in Brooklyn (Joel adds: looks like he made the sale of his life).

Afterthought: I also wrote:

[A]ny institution that is going to make any money has to put up with at least a few of these guys: the point is that you keep them cabined in; surround them with a net of bean-counters, auditors, and execution clerks who save them from the full consequences of their own megalomania. The real flaw in Bear Stearns seems to be that nobody knew how to do it and so Cioffi drove the bus off the cliff.

I think I'll stand by that.

How Jimmy Cayne Got Hired at Bear, Stearns

One theme that dominated the culture of Bear, Stearns (the failed banking house) was bridge--i.e., the card game. Which perhaps explains why, true or not, they would repeat a story like this:

['Ace'] Greenberg [the commanding presence at Bear Stearns] happened to interview Jimmy Cayne, then a thirty-five year-old municipal bond salesman. ... [T]here seemed to be no connection between the two men, but in an effort to make a little small talk, Greenberg asked Cayne if he had any hobbies.

When Cayne told Greenberg he played bridge, 'you could see the electric light bulb,' Cayne recalled. 'He says, "How well do you play? I said, "I play quite well." He says, "You don't understand." I said, "Yeah, I do. I understand. Mr. Greenberg, if you study bridge the rest of your life, if you play with the best partners and you achieve your potential, you will never play bridge like I play bridge."'

William D. Cohan, House of Cards (2009

If you knew anything about Bear, Stearns, you would not be surprised to learn tht Greenberg hired him on the spot. Cayne, of course, rose to the top of the firm, presided over its legenday growth and the beginnings of its percipitous collapse. Perhaps also not surprisingly, he spent the last calamitous days of Bear Stearns Detroit, playing bridge.

Afterthought: House of Cards. Oh, now I get it.

Is Bear Stearns Solvent?

Re a (possible, hypothetical, fanciful) bankruptcy for Bear Stearns—I’ve been part of some offline chat on the question whether Bear Stearns was “solvent.” Of course, insolvency is not a threshold requirement for bankruptcy, but let that pass. Was/is Bear Stearns “solvent”? Do its assets exceed its liabilities?

Take a look at the balance sheet from November 30 (link) (which, as someone has said, is very likely the last ever). That shows equity of $12 billion against liabilities of $384 billion—for those keeping score at home, a debt/equity ratio of 32. I can’t find a figure for market cap back then, but a chicken-scratch derivation from current numbers suggests it might have been around $20 billion.

But now? I suppose one measure of solvency might be that JPM was willing to lay out $270 mill for the equity (of course that’s after a $30 bill put from the taxpayers). If liabilities now are the same as they were then, that makes a D/E ratio of ah, er, huff, puff, 1,422.

But there’s another way of approaching the matter. If you could market-cap all the BS debt today and top it off with $270 mill, I suspect you still wouldn’t have a number as high as the debt on its face. So insolvent. So why an equity stake? Try this: it’s by now common parlance among finance types to treat the equity on a leveraged balance sheet as a call option on the assets. I suspect that what we have here is a deep out-of-the-money call—the flicker of hope that something, somehow, from somewhere, just might turn up. Keep it up, folks, the cavalry is coming! Or maybe not.

Update: As I write (1052 am pst March 18) Yahoo is quoting Bear at 6.88. That would capitalize at over $900 mill. Evidently somebody out there thinks the option is worth picking up.

It's Worse than you Think

Everyody is buzzing this morning about JP Morgan getting Bear Stearns for $270 million, or $2 a share. But it is not $2 a share. It is $2 a share less the value of that $30 billion Federal guarantee. What's the guarantee worth? Ah, who knows? That's a function of the loss on the guaranteed deals. If they are all worthless, the guarantee is worth $30 billion. If they are only 10 percent worthless, Morgan is getting Bear for free, with a $30 million boot.

So chalk up one for the first great winner of the second Bush recession: when the going gets tough, give some tax money to JP Morgan.

Why Didn't the Feds Just Buy Bear Stearns?

Okay, so the Bear Stearns deal is done. JP Morgan puts up $270 (or maybe $236) million in stock--a price which Yves Smith notes is about one quarter the value of Bear's headquarters building (link). The Feds go on the hook for $30 billion as a "special lending facility," heh heh, i.e., a “non-recourse facility to manage up to $30B +/- of illiquid assets, largely mortgage-related” (link). JP Morgan gets the equity in Bear Stearns. The Feds get--ah, let me get back to you on that

The magic word, again, is "nonrecourse," meaning that if the stuff is worthless, the Fed share is, well, $30B +/1. Query, with numbers like that, why didn't the Feds just go the whole way and buy it outright?

More Bear Facts: Kedrosky offers up a Power Point term sheet (link). The term sheet says that Bear Stearns shareholders will get 0.05473 Morgan shares for each Bear Stearns share. Per Yahoo, Morgan last traded at $36.54. So that translates into a value of just a hair under $2 for each Bear share. For a share that traded within the year at $159.36, that pencils out to a top-to-bottom tumble of 98.75 percent.

I see that James E. Cayne who was CEO of Bear Stearns until January, reported holdings of 5,612,922 shares as of last December 21. Using the high-low prices reported above, that would suggest that the value of his holdings has fallen from $894,475,250 to $11,224,914. That’s a kick in the stomach; but of course, even $11 million would be enough to keep most of us in Cheese Whiz through the summer.

But Cayne apparently won’t have to rely on a paltry $11 million. Forbes reported in 2006 that Cayne took $132.14 million in compensation over five years; an average of $27.27 million a year (link). In 2005, Forbes ranked Cayne as the 387^th richest person in America (link).

A news report say that Cayne’s leadership of Bear was “called into question” by the collapse of a couple of Bear-managed hedge funds (link).

Critics of the company said Cayne spent too much time away from the office last year playing golf and bridge as the problems unfolded.

Cayne is the same executive who refused to let Bear Stearns provide support as part of a Federal Reserve-led plan to rescue Long-Term Capital Management in 1998. His reticence was said to deeply anger some of his fellow Wall Street CEOs, and the episode came up every time Bear was reported to be in trouble in recent months.

Afterthought: On sober reflection, I think I’d write this morning’s Bear Stearns post (link) a little differently, although the general drift would be the same. It’s probably not really a going concern v. liquidation issue; I suspect the going concern value and the liquidation value are pretty near the same. But there remains the question of who will maximize the value of the creditor stake after the equity is wiped out. That’s a perfectly appropriate role for an outside stakeholder, be it trustee, or receive, or whatever.

Gretchen Morgenson Doesn't Tell Me What I Want to Know

I see that Gretchen Morgenson has joined the anti-bailout chorus, motivated not least by her animosity against Bear Stearns per se, and the way they have run their business (link). She calls it "this decade's version of Drexel Burnham Lambert," which I suspect may be a libel on Drexel Burnham (but then, you can't libel the dead).

There's a great deal of merit in which she says but she still misses a distinction which I, as a simple, barefoot, country bankruptcy lawyer, would want to pursue. That is: the difference between saving the enterprise and saving the equity. For example (or see it here):

Anyway, the points are (a) the business is underwater, insolvent, upside down--there is nothing for equity either way; but (b) the business is worth more as a going concern than it is in liquidation. So the creditors have a stake in seeing to it that the going concern value is preserved, even if equity is wiped out. That's why God created bankruptcy trustees. That's what banking regulators are supposed to do in banking cases; insurance regulators in insurance cases and receivers/stakeholders in any number of special situations where there is some value to be preserved.

Seems to me there is plenty of room for "bailout" intervention insofar as it means preserving the going concern value. But this sort of thing need have nothing to do with paying off the buffoons who created the problem. Gretchen is a grownup; she ought to understand this. I'd like to know what she thinks of it.

Corporate Socialism to the Rescue

Ah. So Bear Stearns is the first bank to belly up to the front of the dole queue. No, wait, I guess I have to count Northern Rock, although Bear Stearns seems like a whole nother order of maginitude. Maybe the real question is how many more we’ll need before the agony is over—have you read that table of price-to-book values for major players in the mortgage mess (link)? Granted, Bear was the lowest except for dead-on-the-gurney Countryside, but the list went all the way up to (oof!) 1.6.

I don’t mind, really. Igives me another opportunity for cheap snark. And I believe: banking is one industry where I do not gain from my competitor’s failure. And even in the weakest institution, there is probably some going-concern value to be protected against dissipation. It would be nice, though, if just once the government treated this sort of takeover for what it is—a bankruptcy and a sale to creditors. Wipe out the old equity and put the malefactors on the bus. Not likely, I suppose, but one can hope.

Update: For a refreshingly clear outline of the transaction, and a more extended critique from someone who thinks it should not have happened, go here. And don't overlook the comments, particularly this one:

One question: if the government is worried about contagion, wouldn’t it make sense instead of bailing out the company, to instead provide whatever benefit it would have given that company to its competitors instead? Wouldn’t that avoid the moral hazard problem while providing the same level of support for the industry? Or are there systemic risks to an institution failing that I’m not taking into account?

I assume the last question is sarcasm? Brings to mind the comic who said that Eliot Spitzer shouldn't have brought his wife to the press conference--he should have brought the hooker.