Bear Stearns - The Rest of the Story

As a follow on to our Bear Stearns and financial stock discussion from Friday (3/15/08), we now know the rest of the story of Bear Stearns.

Bear opened up at $2 this morning after a Sunday negotiating session with JP Morgan. As we knew / suspected, JPM had the upper hand in the negotiations since it had been annointed by the Fed to back up Bear. No other bank had that distinction of the Fed guarantees for the paper on Bear's books, so could not offer a decent negotiating alternative. JPM was really free to name its price, since the alternative for Bear was to declare bankruptcy today. Also, JPM was able to take on some of Bear's obligations. Those obligations now amount to over $6B, but are guaranteed by the Fed, so are worth close to par. But, anyone else who wanted to buy Bear, would need to pay JPM for those liabilities, but the Fed might not guarantee those obligations, so they might be much more expensive since in that case, they would trade well below par.

Kudos to JPM management (Jamie Dimon, the erstwhile student of Sandy Weill while at American Express is the CEO at JPM) for playing a great game of chess. They correctly saw the opportunity to lock up Bear for a song and played their cards correctly. They outdid the $7 bid by BAC for Countrywide back in November, in terms of shrewd negotiating for assets that will someday bolster their stock.

As for the other financial stocks, including Lehman which was the next in line to fail, they will be propped up by the notion that the Fed will do whatever it takes to stop the bleeding. The stronger of the bunch, like Citi, WFC, BAC and USB, will be the beneficiaries of any further Fed-sponsored consolidation, as we talked last Friday. Because of this move by the Fed, I concluded it was time to cover my shorts this morning. In doing so, I discovered a little anomaly that is interesting from a trading perspective.

The fear had really built up over night in the Asian and European markets. So much so, that the financials were down as much as 10% in the Extended Market (electronic markets that trade before the official open). I was able to cover some of my shorts in this extended market (at 7am my time) for that 10% decline. I held some other of my shorts till after the open, in case the market dropped from there. But the regular market is occupied by American investors, mostly the big institutions. They had yesterday and this morning to digest the implications of the Fed actions. So, at the open, the financials were quickly driven higher. I covered the rest of my financial shorts at a higher price in the regular session than in the extended session.

I also found the market much more volatile in the regular session than in the extended session. The price was really moving around and it was hard to set a price. I dared not cover with a market order because the price was bouncing so much. I would have done much better covering all my shorts in the extended session.

From here, I think the market will settle down a bit and maybe even have a rally this week after the Fed cuts rates on Tuesday. Whether today is the bottom or not, only time will tell. If the market bounces significantly, to the mid 12,000s, I will probably do a little more hedging by selling more shorts. But I will be prepared to cover those shorts at a loss if this proves to be the actual bottom.