By KEVIN KINGSBURY, ANDREW DOWELL and SERENA NGMarch 14, 2008 5:01 p.m.
NEW YORK -- In an unprecedented move Friday, J.P. Morgan Chase & Co. and the Federal Reserve Bank of New York stepped in with emergency funds to keep beleaguered investment bank Bear Stearns Cos. afloat.
The move, after a week of persistent concerns about whether Bear could continue to meet its obligations, took the credit crisis to a new, more serious stage and was a reminder of how quickly an erosion of confidence can undermine even leading financial institutions.
The involvement of the Fed -- coordinating with the Treasury Department and the Securities and Exchange Commission -- made clear authorities were concerned about the risks to the broader financial system. Bear is the smallest of Wall Street's big five investment banks, but it is a significant player in markets for debt, particularly for securities backed by mortgages.
A sharp selloff in the bank's stock and demand for protection against a default on its debts showed the market isn't convinced the plan will stabilize the bank, which now faces the prospect of fighting to convince customers to stick around or finding a merger partner.
Bear Stearns' problems built this week, as counterparties in the market grew extra cautious about entering deals with the bank. Executives tried all week to reassure markets that the bank's financial position was solid. But in a week that also saw the collapse of the $22 billion, mortgage-focused hedge fund Carlyle Capital, those reassurances went unheard, and Bear ultimately was forced to seek help.
"We have tried to confront and dispel these rumors and parse fact from fiction," CEO Alan Schwartz said in a release. "Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated. We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations."
Friday afternoon, Standard & Poor's cut its long-term credit rating on Bear Stearns by three notches to BBB and said further downgrades are likely, noting the company's liquidity squeeze.
S&P said, "Bear has been experiencing significant stress in the past week because of concerns regarding its liquidity position. Although the firm's liquidity, at the beginning of the week, held steady with excess cash of $18 billion, ongoing pressure and anxiety in the markets resulted in significant cash outflows toward the week's end, leaving Bear with a significantly deteriorated liquidity position at end of business on Thursday."
S&P said it current ratings "are based on our expectation that Bear will find an orderly solution to its funding problems. However, although we view the liquidity support to Bear as positive, we consider it a short-term solution to a longer term issue that does not entirely affect Bear's confidence crisis. We also remain concerned about Bear's ability to generate sustainable revenues in an ongoing volatile market environment."
Moody's Investors Service cut its rating on Bear Stearns to Baa1, three levels above junk.
Fed Steps In
J.P. Morgan will borrow funds from the Fed's discount window and re-lend them to Bear Stearns for 28 days, with the Fed bearing the risk of any losses. The size isn't predetermined, but is limited by the available collateral.
The arrangement employs a little-used Depression-era provision of the Federal Reserve Act. New York-based J.P. Morgan, unlike investment banks like Bear, has the advantage of being able to borrow directly from the discount window and, with just over $3 billion in write-downs thus far, has weathered the credit crisis far better than commercial banking peers like Citigroup Inc.
The timing of the move made its urgency clear. If Bear could have held out until March 27, it could have borrowed directly from the Fed itself under a new program announced just Tuesday.
The developments could mean the end of independence for Bear, founded in 1923. J.P. Morgan is "working closely with Bear Stearns on securing permanent financing or other alternatives for the company" -- Wall Street lingo for a sale or other strategic-level change -- and CNBC reported that the bank is "actively being shopped" to potential buyers. Mr. Schwartz said on a conference call that the bank is considering the full range of options.
The cost of protecting investments in Bear Stearns debt against default jumped sharply, indicating growing concerns about Bear's creditworthiness. Similar protection for other financial companies also rose in value, a sign of rising worry in the markets.
Bear's shares plunged, dropping by more than half at the day's low. Shares recently were trading nearly 42% lower at $33.07, knocking around $3 billion in market value off the stock. The options market signaled a dim outlook, with contracts giving the right to sell Bear Stearns stock for $25 soaring in value. The shares have fallen by two-thirds in the past three months.
The news also unnerved the broader markets, which just yesterday were cheering a report from Standard & Poor's that suggested the end might be in sight for write-downs related to subprime mortgages. The Dow Jones Industrial Average was down about 300 points at its low but closed down 195 points.
U.S. Treasurys surged, as investors sought a safe place for their money, and the dollar fell.
"It's just pure fear across the board right now," said Geoffrey Yu of UBS. "All the promising news this past week has been undone over this Bear Stearns news. ... I don't think the market has seen anything of this magnitude before, such a big bank."
Bear Stearns started this week with sufficient access to cash, but persistent rumors rattled lenders, clients and counterparties, prompting a run on the bank, Mr. Schwartz said on the call.
"A lot of people wanted to get cash out," he said. "We recognized that, at the pace things were going, there could be continued liquidity demands that would outstrip our liquidity resources."
Lehman Parallels
Analysts and investors say Bear's predicament has parallels to what Lehman Brothers went through during the late 1990s.
During the credit crunch of 1998, which was sparked off by the Russian debt crisis and the implosion of hedge fund Long-Term Capital Management, Lehman was the subject of rampant market speculation that it might face financial difficulties, because it held emerging market bonds and other assets that were falling in value.
As Lehman's shares and bonds dived on the rumors, the Wall Street firm, which at the time depended heavily on short-term funding, ran into problems obtaining such financing. It fought its way out of the trap without having to turn to the Fed, however.
"The nature of financial companies is that they are pretty much a black box," says Jeff Houston, a bond fund manager at American Century Investments in San Francisco. "If people start to worry about what's in the box, there's not much the firms can do to demonstrate that they are not as weak as they appear to be."
Lehman's shares dropped 11% Friday -- outpacing declines of roughly 3% for its investment banking cohorts. The bank is bigger and more diversified than Bear geographically and across business lines, but is smaller than Goldman Sachs Group or Morgan Stanley.
Lehman said late in the day it closed a $2 billion unsecured credit line. Global Treasurer Paolo Tonucci called it "a strong signal from the market and our key bank relationships."
At the end of November, Bear had short-term borrowings of $24 billion, of which $11.6 billion was unsecured and $12.4 billion was secured. It also had $68.5 billion in long-term borrowings and $21.4 billion in cash or equivalents, according to regulatory filings.
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