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Tuesday, March 18, 2008

Bear Stearns Takeover

By E-Mail, someone asked:

What's your take on the Bear deal?

The Bear Stearns shareholders got hosed.

Bear Stearns *IS* highly leveraged. Due to margin calls, they have no choice but to sell their assets, RIGHT NOW AT THE BOTTOM OF THE RECESSION. If Bear Stearns were forced to fully liquidate RIGHT NOW, their shareholders would get less than the $2/share JP Morgan Chase offered.

All those loans are for a negative real interest rate. Fast forward in time 2 years. All of Bear Stearns' debt has a negative real interest rate of 3%/year, whereas the underlying assets will increase in value at a rate of 15%-20%/year. The true inflation rate is 15%-20%/year. If Bear Stearns could wait two years, they would profit handsomely.

Due to margin calls, Bear Stearns is unable to hold onto its positions. Bear Stearns bet with extensive leverage. Such bets are usually favorable, due to negative real interest rates. Bear Stearns wasn't able to hold on until after the end of the economic bust phase.

With a market value of less than $1B, Bear Stearns is a "small" bank. The "too big to fail" doctrine only applies to large politically-connected banks.

Also, the bailout is financed by the Federal Reserve. JP Morgan Chase is buying Bear Stearns' assets and debts, but they are taking *ZERO* downside risk. If the assets turn out to be worthless, the Federal Reserve will take the loss. When inflation runs its course and JP Morgan Chase profits, all the upside accrues to JP Morgan Chase.

The Federal Reserve is giving JP Morgan Chase a put option to sell Bear Stearns' assets for $0. Valuing Bear Stearns as an out-of-the money call option, $2/share is a reasonable value. If Bear Stearns has a book value of $80/share and debt of $100/share, then $2/share is a reasonable price for the value of the option.

No competing buyers for the takeover are emerging. The Federal Reserve guarantee is part of the buyout. Another bank could make a bid for Bear Stearns only if they *ALSO* received a Federal Reserve loan guarantee.

Bear Stearns' loss is JP Morgan Chase's profit. JP Morgan Chase recently profited from another high-profile bankruptcy: Amaranth.

As a clearing firm, JP Morgan Chase is "too big to fail". They will always receive a bailout, paid by everyone else as inflation. In the Bear Stearns case, Bear Stearns' shareholders are losers and JP Morgan Chase's shareholders are winners. JP Morgan Chase will hold onto Bear Stearns' assets and debts. In 1-2 years, there will be inflation, and JP Morgan Chase will sell those assets for a tidy profit.

Even though there's a lot of talk about Bear Stearns and their Federal Reserve, the true culprit is never mentioned. Nobody is mentioning the Compound Interest Paradox and the fundamental structural flaw in the US monetary system. Under the rules of a corrupt monetary system, such crises are *INEVITABLE*. They must occur every few years.

Like all large banks, JP Morgan Chase's profits aren't free. They're paid by everyone else as inflation.

BTW, I interviewed for a job at Bear Stearns awhile ago. Their heads were pretty far up their ***es. When I invest in a bank, I only invest if I interivewed for a job *AND* got a favorable impression. I judge "favorable impression" on a relative scale.

For example, Citigroup gave its software engineers individual cubicles! Compared to the setup at other large banks, that's so much better!

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