JP Morgan and Bear Stearns Essay

BackgroundIn the last trinity decades, the US situateing system has changed its coronation procedures and its jeopardy management out-of-pocket to changes in regimen regulation. Furthermore, out-of-door shocks, such as the inflationary period during the 70s and the recession in the 80s, led Banking institutions to alternative ways of investment in hostel to endure profitable. The average annual inflation ordain from 1900 to 1970 was approximately 2.5%. From 1970, however, the average rate hit about 6%, topping out at 13.3% by 1979. This period is also feeln for stagflation, a phenomenon in which inflation and unemployment steadily change magnituded. A loose monetary policy led to very pathetic interest rates. Corporations were borrowing large amounts to finance leverage buyouts (LBOs), which led to high and high interest burden. One of the main instruments pulmonary tuberculosisd was financial derivatives, which gave Banks supererogatory profit. Moreover, this instr uments represented off ease sheet activities, thus helping bank capital.Nonetheless, these instruments were risky and could led to enormous losses. In the late 70s and early 80s saw the rise of a bit of financial products such as derivatives, high yield an structured products, which provided compensable returns for investment banks. Also in the late 1970s, the facilitation of corporate mergers was be hailed as the last gold mine by investment bankers who assumed that Glass-Steag all(prenominal) would someday collapse. At this time we could see the first efforts to loosen Glass-Steagall restrictions and some brokerage house warms begin encroaching on banking territory by crack money-market accounts that pass on interest, allow check-writing, and offer credit or debit cards. Moreover, in 1974 at one time (Negotiable Order of Withdrawal) accounts were created by a small bank in Massachusetts, offering negotiable arranges of withdrawal to permit payments on near-checking acco unts at banks. In 1980, they were permitted for all institutions, with rate ceilings eliminated in 1986. turn back Sterns and crisisAs an investment bank, arise Stearns & Co. had three main run nonees. The first one was Capital Markets, which included brokerage services, market-making and proprietary trading in both equities and fixed income. Moreover, this Capital Markets business also included investment banking services such as securities issue and advice on mergers andacquisitions. Its fixed income business represented the highest contribution to its revenue. The second operational business was Global Clearing Services which included the conjunctions well-regarded prime brokerage business. indorse Stearns provided trade execution and securities clearing, custody, lending and financial backing to hedge pecuniary resource and broker-dealers as a prime broker. The third operating business was Wealth Management which included Bears mystical Client Services group, which se rved high-net worth individuals, and Bear Stearns Asset Management, which managed hedge funds and other investment vehicles.Bear Stearns & Co. was an investment bank, a financial go-between that performed a variety of services. As an investment bank it specialized in large and complex financial transactions. Its primary regulator was the Securities and Exchange thrill and did not study access to the Federal Reserve discount window, which allows pensionable institutions to borrow money from the central bank, usually on a short basis, to meet temporary shortages of liquidity caused by internal or external disruptions unlike commercial banks. The main difference between a commercial bank and an investment bank such as Bear Stearns was that piece commercial banking involved both taking deposits and making loans that remained on the lenders balance sheet, investment banking involved the underwriting of debt and virtue securities, buying them from the issuer typically with a syndica te of other firms and then selling them on to investors. many an(prenominal) years ago it was difficult to say whether a bank meshed in commercial activities or investment activities, however, the Congress prohibited investment banking and commercial banking in the same firm in 1993. But in 1999 these laws were modified and some commercial and investment banks consolidated although Bear Stearns as well as other banks such as Goldman Sachs and Lehman Brothers chose not to autograph the commercial banking business so as a result they did not have access to the Federal Reserve discount window. FED chairwoman Christopher Cox said that Bear Stearns was adequately capitalized at all times but facing skeptical lawmakers, Cox acknowledged that the firm had abundant liquidity problems and that capital is not synonymous with liquidity. He said the secondment is working with the five biggest Wall Street firms to make sure they increase their liquidity pools andredouble their focus on risk practices. On show 13, he indicated that liquidity at Bear Stearns fell from $12.4 billion to $2 billion because of the complete evaporation of confidence in the company.Considering Mr. Coxs statements, we ask ourselves if all well-capitalized financial institutions are vulnerable to crisis periods. In order to arrive to a conclusion in this matter we have considered a well-capitalized as a firm with a healthy liquidity status. From our prefigure of view, we consider that some financial institutions, such as big investment banks, are so important to the global economy that should they fall, the repercussions would be in addition fatal and governments would be forced to intervene and rescue them in order to keep the economy from collapsing. This is the reason why the term to big to snap arose. In spite of this, as Nassim Nicholas Taleb said, we could face a black rely case, which refers to an event, positive or negative, that is deemed improbable yet causes massive consequences . Bears activities were financed with a mix of long term debt, equity, and financing collateralized with securities from Bears inventory.Besides this, Bears trading business inevitable the investment bank to constantly hold an inventory of securities these securities were used as collateral for short term borrowing agreements known as repurchase agreements (repos). If we compare Bear with other financial institutions like, for example, Leman Brothers, Merrill or Morgan Stanley we can slowly see that those companies had much more weight in liquidity than Bear Stearns. It was below those three in repo financing and repo lending too. Specifically, Merrill Lynch had lend liquidity of 181.9 while Bearn Stearns had 35.3 and total liquidity as percentage of repo financing was 77% in Merrill and 345 in Bearn Stearns. Bear Stearns nearly collapsed not erstwhile but twice before the cash-strapped brokerage firm was rescued.The leverage suffered by Bear Stearns at that time increased the r isk of becoming bankrupt. This was because, with a big leverage, losses are larger and can consume the firms entire equity to the point where the book value of the company is zero or even negative. In the worst case scenario, Bearn Stearns, being counterpart for many repo agreements and other financial instruments could result in nonremittal on their payments, which is why it cease up being rescued. By conditioned this facts we can tell that the firms value would indeed be negatively affected by a potential bankruptcy.ValuationTo reserve a price to pay for Bear Stearns ongoing businesses we have to use a valuation method. Being unable to perform an adequate due diligence we are not going to be able to know the actual risk of many of the assets, and therefore unable to use the unfeigned value. For this reason, the valuation method we are going to use is the Book cling to per Share, which by definition indicates the remaining value of a company for its shareholders, should it di ssolve, which is sooner similar to the process Bear Stearns is going through. To find the book value, we have to take the total shareholder equity and subtract from it all preferred equity. In order to do so, we have to take a note at the balance sheet, provided in the Exhibit 2, where we can find the unaudited balance sheet for the Q1 2008.There we can see that Total Stockholders Equity in that period was $11,896 million. From that equity we have to subtract the preferred stock, which is $352 million. 11544 Doing so we earn a value of $11,544 million, which divided by the weigh of total shares capital should give us the book value per share of the company. Looking at the balance sheet, we can see that it gives the outstanding shares. We have 500,000,000 shares authorized as of November 30, 2007 and 2006 184,805,847 shares issued as of November 30, 2007 and 2006. We can see it better this wayNov. 30, 2007Nov. 30, 2006Authorized500,000,000500,000,000Issued184,805,847184,805,847T his makes a total of 1,369,611,694 shares. But the company also has Treasury stock, it has repurchased some of the shares it had antecedently issued. It says that the treasury stock is composed of common stock 71,807,227 and 67,396,876 shares as of November 30, 2007 and 2006, respectively. This manner that the company has bought, in total, 139,204,103 shares. Subtracting thevalue to the issued and authorized shares, we have the total number of outstanding shares. So, to find the Book Value per share, we divide the $11,544 million of equity by the 1,230,407,591 shares, turning to be $9.38 per share, very close to the price JP Morgan ended up paying. However, I would say this value is too high, due to the cracking amount of uncertainty regarding the exposition of Bear Stearns to the MBS market and the great illiquidity risk it is facing.