As I sit down to write this piece news just hit the tape that JP Morgan will buy Bear Stearns for $2 a share having closed on Friday at $30 down 47% on the day. “The deal marked a 93.3 percent discount to Bear Stearns' market capitalization as of Friday, and roughly a 98.8 percent discount to its book value as of Feb. 29… or 1% of what the company was worth 16 days ago” reports Yahoo.com. (http://biz.yahoo.com/ap/080316/jpmorgan_bear_stearns.html ) Bear was too big to fail and the FEDERAL RESERVE came to the rescue. Barron’s reports that it is “tough to say what Bear is worth” but they highlighted two spots of value, their prime brokerage business which “generated $566 million in pre-tax profits last year. At six times earnings an appropriate multiple would be $26 a share.” Add to that the value of their office building which they say is worth $12 a share and it might seem that JPM is getting a bargain. Not so fast. What this more likely means is that the value of their asset base is at least $36 a share worse then people think. Bear’s asset base at the end of November was $395 bln, with only a $12 bln book value that implies some 30 times leverage.
The folks who spent the weekend at the firm trying to ascertain the value likely had no easy task and it is unclear what will happen to those assets this week. Though the language is sketchy it appears that JPM has a made a deal with the FED for ‘special financing,’ which may mean there will be no forced selling which could have made problems even worse. From everything I read over the weekend, and listening to Treasury Secretary Hank Paulson’s on FOX NEWs today, it was clear that the FED and the Treasury will continue to do everything they can to stabilize the markets. The question remains, can they do enough to prevent further problems? The answer clearly has to be NO WAY and the most they can hope for is to try to keep it somewhat orderly. The massive deleveraging has to run it’s course, and we are not even close to the finish line. I applaud both institutions for what they are doing, but it won’t be enough.
The reason for saying this is because FED loans, albeit helpful, do not solve the core problem. The lack of transparency coupled with the incredibly complexity of financial instruments has rendered balance sheets nearly impossible to analyze. Free markets can only function in a system where a company’s credit worthiness can be assessed independent of a letter grade supplied by a rating agency. However, the truth is that this is simply no longer the case. And, in times of stress, any prudent buyer will charge a huge discount to compensate them for uncertainty, especially when a company leverages it equity twenty or thirty times. Is Bear Stearns worth $2/share. Who knows? I’m not sure that even JP Morgan knows. However, before one can declare that this financial crisis is over, the markets have to be able to make this kind of assessment. Unfortunately, we are not there yet.
Weekly Market Performance and Benchmarks
DJ Indus close 11951 +57.40 +.48% -9.9% ytd
S& P 500 close 1288 -5.23 -.40% -12.2% ytd
Crude Oil 110.21 last week 105.16
Gold 998.10 last week 972.20
10 Yr Treas 3.43%
What To Watch This Week
- Other investment banks are reporting earnings – Goldman, Lehman and Morgan Stanley. Question is, how bad will it be? The market will be watching all financial institutions closely, worrying about who might be next to go.
- There have got to be other hedge funds in trouble, I am sure they will start to surface.
- The FED meets on Tuesday for an expected cut of the fed funds rate to 3%.
- The Fed is clearly going to continue to pump the system with liquidity which should be good for Gold and bad for the US Dollar.