Why JP Morgan upped the bid for Bear Stearns

It’s hard to imagine J. Pierpont Morgan bidding against himself in a rescue takeover like the one for Bear Stearns. “There’s the deal,” he would have said to himself. “You can come out of the library when you’ve signed.”

That the current CEO of Morgan, Jamie Dimon, has suddenly raised the offer for Bear Stearns from $2 a share to $10 a share against a vast absence of alternatives is a sign that moral hazard is alive and well and that these days the lawyers are in charge.

The fact that JP Morgan’s lawyers made a mistake, according the New York Times, didn’t help either.

The Times says Wachtell, Lipton, Rosen & Katz “inadvertently” included a sentence in the original contract that would have given Bear Stearns shareholders the ability to block the sale and seek a higher offer while still forcing JP Morgan to guarantee Bear’s trades. Dimon was said to be “apoplectic” and looking for ways out of it, but by Friday was back seeing Alan Schwartz, the Bear CEO, to renegotiate the deal.

Meanwhile a telephone book of lawyers was circling. Skadden Arps Slate Meagher & Flom were advising Bear Stearns; Sullivan & Cromwell were brought in by the Bear board; Stember Feinstein Doyle & Payne had announced they were investigating a suit against Bear Stearns; Coughlin Stoia Geller Rudman & Robbins had already filed a suit in the Manhattan federal court; Bernstein Litowiz Berger & Grossman also said they were preparing to file on behalf of aggrieved shareholders.

Then there was British financier Joe Lewis, who had invested $US1.25 billion in Bear Stearns and lost 98 per cent it, ranting from London about doing everything he could to block the deal.

And Bear Stearns executives and employees were weeping to reporters in the street during cigarette breaks – angry, dismayed, frightened, you name it. Some of these people had lost $US100 million in executive shares and options, according to reports, and those who didn’t smoke already were taking it up.

Even Jimmy Cayne, the cigar-chomping former CEO and current chairman, was bewildered and angry and talking to Joe Lewis about some kind of joint action. He had been coming to work every day, but apparently wasn’t involved in the deal.

So Jamie Dimon – apoplectic, desperate, cornered by lawyers and whined at by employees – quintuples the bid unnecessarily.

In return, Alan Schwartz agrees that Bear Stearns will issue JP Morgan new shares equivalent to 39.5 per cent of its capital, and that the board, with 5 per cent of the stock, will also vote in favour.

Apparently in Delaware, where both firms are registered, it’s OK for the bidding company to vote its own stock in favour, even if it’s issued as part of the deal, so that gives JP Morgan 44.5 per cent of the vote and pretty well guarantees that it gets up. No wonder all these firms are registered in Delaware.

Anyway, the other leg to the new deal is that the New York Federal Reserve Bank will buy $US30 billion of Bear Stearns’ worst assets, as long as JP Morgan agrees to pick up the first $US1 billion of any losses on them.

It’s moral hazard upon moral hazard. And it doesn’t exactly enhance Jamie Dimon’s reputation for steadfastness and tough dealing.

Previously it could be argued that the Bear Stearns takeover was not a Fed bail-out because the shareholders were getting wiped out (although it really was a bail-out – even the original deal would not have been possible without the Fed’s $US30 billion guarantee). Now it’s definitely a bail-out.

When the dust settles, the Fed and the legislators will have to address whether the “shadow banking system”, as the unregulated investment banks and securitisers are being called now, should be regulated as banks if they are going to be rescued as banks.

But for the moment all concerned will be holding their breath hoping another one doesn’t bite the dust.

As one Bear Stearns investment banker told a reporter during a cigarette break from the mayhem inside: “Basically we’re all wondering first, if we’ll keep our jobs, second, if we’ll get severance if we don’t.”

“And then we’re hoping that Lehman won’t go under because then there will be way too many bankers looking for jobs.”

 

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