Bear Stearns' Big Bailout

JPMorgan Chase and the federal government team up on a bailout of Bear Stearns, a last-ditch move to save the investment bank

Alan Schwartz, president and CEO of Bear Stearns. Daniel Acker/Bloomberg News /Landov

By Matthew Goldstein

Bear Stearns (BSC) is clawing to stay alive, with many on Wall Street now betting the storied investment bank may not survive the weekend as an independent shop.

Bear's stock was in a free fall Mar. 14—hitting an 11-year low—following the news that JPMorgan Chase (JPM) and the New York Federal Reserve had stepped in with an emergency cash bailout for the New York-based investment firm. The bailout was engineered after days of denials by Bear executives that the firm was facing a liquidity crisis and lacked sufficient funds to continue operating. Bear's stock finished down 47% at 30, on volume that was more than 18 times normal trading. JPMorgan dipped 4% to 36.54.

Bear Stearns CEO Alan Schwartz says the situation at Bear took a turn for the worse during the past 24 hours and the firm's liquidity situation had "significantly deteriorated." In a conference call Friday afternoon, Schwartz says "nervousness in the market" prompted clients and lenders to "get cash out" of the firm. Schwartz says, "A lot of people wanted to act from the possibility of the rumors being true." He says before the turmoil, Bear had been working with investment firm Lazard (LAZ) to explore "alternatives" and those discussions will continue. Bear officials also said the decision to seek aid from JPMorgan was their decision. Sources say one reason Bear may have turned to JPMorgan stems from the fact that the bank is already one of the investment firm's main lenders and the big bank has an incentive to see Bear remain in business.

Schwartz and other top executives at Bear are trying to put on a brave face, saying the firm will be able to weather the current storm. But many on Wall Street, and even some within Bear, aren’t sure. Oppenheimer (OPY) brokerage analyst Meredith Whitney says Bear’s prospects are bleak, noting: "A company is only as solvent as the perception of its solvency." One source says many employees at the 85-year-old investment firm are worried about the future and what will happen on Monday. The fear is the longer the firm is perceived as existing on life support, it will be hard to retain wealthy customers—both individuals and hedge funds.

As recently as Mar. 12, Schwartz had taken to the airwaves, appearing on cable channel CNBC (GE) to shoot down rampant rumors that Bear was facing a liquidity crisis. Earlier in the week, Bear had issued a press release denying the rumor. Even Alan "Ace" Greenberg, Bear's legendary former chairman and CEO, had put out a statement denying the investment firm was in trouble.

Bear Rescued from Failure

It's not clear what had changed so dramatically at Bear to necessitate the emergency bailout, in which JPMorgan is providing a secured line of credit to the beleaguered investment firm. But events appear to have moved quickly on Mar. 13. People familiar with the situation say Bear officials called the Fed late in the day, saying the firm had a funding problem. Officials from the Fed were at Bear's spacious offices on Madison Avenue all night, scouring its books and trying to devise a rescue plan. The Fed and Bear then reached out to JPMorgan, seeing if the big bank led by CEO Jamie Dimon could help out. JPMorgan, which has multiple business relationships with Bear, was inclined to do so. But only with some guarantee from the Fed that it would make JPMorgan whole if Bear were to fail and couldn't make good on its obligations. So if Bear fails, everyone in the U.S. will indirectly own a little piece of the company.

It would have been highly risky for other Wall Street firms if Bear Stearns had been allowed to go under because Bear is tightly interconnected with them as both a borrower and a lender. Any firms that are owed a lot of money by Bear would have fallen under suspicion, on grounds that they might not be able to pay their own debts if Bear failed to pay them. That could have triggered a dangerous wave of defaults. The rescue by JPMorgan Chase gives the financial system breathing room to pay off Bear's debts gradually.

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