Bear Stearns is finished

I am writing this from a wedding in Guatemala (lovely, but another story altogether). Still could not help but gape at the Bear Stearns debacle.

In case it was not already obvious to everyone, if JP Morgan does not step in to buy Bear Stearns this weekend, Bear Stearns will end up in bankruptcy court on Monday; otherwise nobody is going to trade with them and there will be a continued run on the bank. They are actually "lucky" they had a weekend intervening so that they have a shot at a sale.

JC Flowers is being batted around in the press as a potential buyer doing due diligence but that is an absurd proposition. What Bear needs to regain market confidence is a gigantic balance sheet behind it and only JP Morgan can provide that. Citi normally could, but it is facing too many losses of its own to do that.

The problem is that Dimon does not particularly want Bear, except for its prime brokerage business, but my guess is that he will be a good corporate citizen and make this happen because it is going to cause massive financial disruption if Bear (a counterparty to god knows how many transactions) goes into receivership.

The employees of Bear Stearns are going to be hurt severely in either case. Long-term incentive packages for senior executives tied up in Bear stock are either going to 0 or a fraction of their value one week ago and a lot of people are going to lose their jobs in any scenario.

It goes without saying that blame for this rests on the CEO and Chairman. Maintaining market confidence in your liquidity is Job #1 for an investment bank. Without that, it is all over. After its near-death experience in August, Bear should have overcompensated. (Amazingly Jimmy Cayne appears to have been playing in a bridge tournament again this week like he was during the hedge fund collapse in August You'd think there would have been something useful he could have been doing at the office during, well, the biggest crisis in the firm's history. History will not judge that kindly).

I am not a fan of investment banks as a whole. They set up incentive systems that only seem to have short-term employee compensation in mind regardless of what collateral damage they do to the balance (shareholders) and the broader economy and while they are happy to privatize gains, they have no problem socializing losses. Right now, you, the taxpayer have are taking on credit risk for billions of dollars of Bear's assets.

But that said, this is stupid and pointless to be happening - the 5th largest investment bank in the country should not be BKing in a distress/fire sale and really this is senior management's fault for getting the firm in that position.

Beyond that, banks #1 to #4 seem ok for now. Lehman is the smallest but seems to have learned from its near-death experience in 1998 and is structured relatively conservatively. I personally I am looking for more excitement from Citi. There is still all types of nonsense on its balance sheet.

And beyond that, it is only a matter of time before we have a systemic disruption driven from derivatives and counterparty issues at which point Buffett will look prescient again. But that is for a different day.

Posted on March 16, 2008 and filed under Finance.