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Bear Stearns Bail Out -- No Such Thing As A Free Lunch

This past weekend's bail out of Wall Street investment bank Bear Stearns proves the old aphorism that there's no such thing as a free lunch. As detailed by CNN, the Fed's agreement to buy up to $30 million in troubled Bear Stearns mortgage bonds gave JPMorgan the incentive to go forward with the Bear Stearns purchase.  In the absence of the Fed's intervention, JPMorgan was set to pass on the purchase, largely because of concerns over the risks tied to Bear Stearn's mortgage portfolio.  As a result, the deal went through Sunday night, with JPMorgan buying up Bear for $2 a share, or a 93 percent discount on its closing price Friday.

But the Fed's role in keeping the deal alive comes at a cost.  For starters, the deal has been widely criticized as a display of favoritism for business interests.  Says Kurt Eggert, a law professor at the Chapman University School of Law in a quote in the Chicago Tribune Blog:

As the Fed rides to the aid of Bear Stearns, there is a growing disconnect between the Bush Administration's willingness to help Wall Street and its willingness to aid the homeowners facing foreclosure. The subprime crisis is largely caused by excessive defaults and foreclosures, and coming up with [a] real plan to reduce foreclosures should be the first point in the agenda...Of all the investment houses, Bear Stearns was the one most deserving of going under because of the subprime crisis, both for its ownership of a subprime lender and its work packaging those loans. However, the Feds are doing more to help Bear Stearns than the borrowers facing foreclosure because of Bear Stearns actions.

But criticism is the least of the problems for the transactions.  Now, Reuters reports that Bear Stearns shareholders are considering lawsuits regarding possible legal claims over the $2 a share stock sale.   Some investors purchased stock last week following Bear CEO Alan Schwartz's televised interview that the company had $17 billion in excess cash on its balance sheets.  Now, they contend that the company was not truthful in describing its financial condition.

In response, Bear Stearns' directors have justified the firesale as preferable to filing for bankruptcy.  As Gordon Smith points out at the Conglomerate, Bear's "better off than bankruptcy" argument means that courts will apply the business judgment rule to evaluate the directors' decision to sell, effectively placing the validity of the deal beyond scrutiny.  Still, Professor Larry Ribstein notes that  the sale is not yet a done deal because "the shareholders, many of whom are Bear employees, will have the last word – they get to vote on the deal."

So stay tuned... there are plenty more developments likely to emerge.

Posted by Carolyn Elefant on March 17, 2008 at 05:09 PM | Permalink | Comments (0)


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