I’ve been withholding comment about the Federal Reserve Bank’s Bear Stearns intervention until I’ve had a chance to appraise the deal, including the extent of Bear’s trouble at the time and what the results will be for the economy and taxpayers. I had initially been skeptical, as I am of any type of intervention, but the issues were so complex and already layered in so many knots of subsidies and regulations, that I thought maybe there was no choice.
But after having looked the deal over, and the $30 billion in loans to Morgan that taxpayers would be on the hook for, I now see even less of a rationale for the internvention. Forcing the merger of Bear with JP Morgan Chase, which is basically what the government did, and offering gurantees so there will be very little downside risk for the Morgan is a horrible long-term precedent for the taxpayers, shareholders and the U.S. economy.
The worst thing about this bailout was that the government sided with creditors and bondholders at the expense of shareholders of Bear Stearns common stock. By forcing this fire sale, the Fed ran roughshod over thousands of investors’ interests, and whatever effects this has on the credit market it may do untold damage to the retail investor market for equity in firms through common shares.
Now, some large shareholders are fighting back. See this New York Post article on “Bear hunting.” The Morgan acquisition still has to go to a shareholder vote, so despite impressions from the media, it is far from a done deal. Other banks, brokerage houses, and private equity firms are reportedly have reportedly expressed interest in acquiring all or part of Bear. But the government has made it difficult for them to do so by giving Morgan the special backing of accepting its mortgage-backed securities as collateral. “Picture the Fed standing at the door with a shotgun,” quips Wall Street Journal’s “Deal Journal” blogger Heidi Moore.
It’s not too late for the government to do right by taxpayers and Bear shareholders. The government should withdraw its offer to guarantee Bear’s mortgage-backed securities, and at the very least, not ride further roughshod over these shareholders and Bear’s other suitors.
My objection is not solely to the low price shareholders are offered. — $2 a share for a company selling for $30 a week ago and more than $80 at the beginning of the year. Shareholders, like creditors and bondholders, take different risks when they invest in a company. As owners, shareholders reap more returns when a company does well, but are the last in line — behind creditors and then bondholders — when a company goes bankrupt. But in this case, the government played favorites and backed a deal that protected creditors and bondholders from risk by likely worsening the result for shareholders.
The justification that Bear was “too big to fail” and default on it creditors doesn’t stand up to scrutiny. In a brilliant dissection of the deal on the Wall Street Journal editorial page, the Manhattan Institute Nicole Gelinas writes that “a bankruptcy would have generated something more valuable than a short-term, soon-to-wear-off boost in confidence. That something is knowledge.” Letting Enron and WorldCom fail, as Bush did early in his administration, did not mean the collapse of American financial institutions. Neither would letting Bear fail.
And probably if creditors knew that the government wouldn’t protect them from their own risks, Bear likely wouldn’t have gone bankrupt. If Bear were truly “too big to fail,” than its creditors would have a vested interest in keeping it from failing. They would negotiate payment plans that would keep it solvent and able to repay them, albeit perhaps a little slower than they would like. Without a bailout, Gelinas argues, creditors would probably be “pressuring each other not to flee … institutions like Bear.”
This is epecially true given that the value of these securities are in flux. Any value is an estimate because no one knows how many loans in the securities will be repaid. But given that still only 2 percent of mortgage loans are in the foreclosure process, a good many loans will be repaid.
Bear’s officially stated book value is $85 per share. Perhaps that is too high, but even if the book value were half that amount, $40 is still quite a bit higher than the $2 that Morgan plans to pay shareholders. Investors have every right to seek a better offer, pursuant to company bylaws and the laws of the state where the company was incorporated. The Fed and the Feds should not stand in their way. A freeze in the rule of law is still much more dangerous than even severe chilling in the credit markets.