Soap and Bubbles on the Wall Street
They say that the biggest movers in the Financial Market is 'greed' and 'fear'. Greed, that one wants more and more gains on one's market portfolio. Fear, that one would lose on capital or be too late and lose out on good opportunities.
It's a reminder that in a business based on confidence, when that confidence evaporates, so does the business.
It was initially thought that only few of the big names were left holding the subprime losses. But as the script unfolds we find that more and more supposedly reputed institutions are also involved. The way it unfolds, what the heck, within a couple of months all of us will be wearing potato-sacks and standing in the bread-line for the squirrel soup. Here is a list of the casualties in the credit crisis, as they went:
- Bear Sterns
An urgent intervention by the Federal Reserve failed to revive the investment bank already hit badly by the sub prime mortgages in a falling real estate market. Bought by J.P. Morgan Chase.
The firm had some $17 billion in cash. Bear was noted for its addiction to leverage even at a time when Wall Street, which runs on debt, was drunk on the stuff. Bear had $11.1 billion in tangible equity capital supporting $395 billion in assets, a leverage ratio of more than 35 to one. And its assets were less liquid than those of many of its competitors. Late the preceding Friday March 7th 2008, a major bank had rebuffed Bear's request for a short-term $2 billion loan. Such securities-backed repurchase (or "repo") loans are crucial for investment banks, which borrow and lend billions to fund their daily business. Being denied such a loan is the Wall Street equivalent of having your buddy refuse to front you $5 the day before payday. Bear executives scrambled and raised the money elsewhere. But the sign was unmistakable: Credit was drying up.
March 14 2008, D-day. Bear's stock dropped nearly 40% in the first half-hour of trading. Within days, Bear's 85 years as an independent entity were at an end.
Bear Stearns agreed late Sunday to sell itself to JPMorgan Chase for a mere $2 a share, narrowly averting a collapse that threatened to cascade through the financial system. The price represents a startling 93 percent discount to Bear Stearns’ closing stock price on Friday on the New York Stock Exchange. The deal, done at the behest of the Federal Reserve and the Treasury Department, punctuates the stunning downfall of one of Wall Street’s biggest and most storied firms. Bear Stearns weathered the vagaries of the markets for 85 years, surviving the Depression and a dozen recessions only to meet its end in the rapidly unfolding credit crisis now afflicting the American economy. Reflecting Bear Stearns’s dire straits, JPMorgan agreed to pay just $236 million for the firm, a figure that includes the price of Bear’s soaring headquarters on Madison Avenue in Manhattan. At $2 a share, JPMorgan is buying Bear Stearns for a third of the price at which the troubled firm went public in 1985. Only a year ago, Bear’s shares fetched $170. The cut-rate price reflects deep misgivings about the firm’s prospects. JPMorgan said it was guaranteeing the trading obligations of Bear Stearns and its subsidiaries, effective immediately. “JPMorgan Chase stands behind Bear Stearns,” Jamie Dimon, JPMorgan’s chief executive, said in a statement. “Bear Stearns’s clients and counterparties should feel secure that JPMorgan is guaranteeing Bear Stearns’s counterparty risk.” The companies said that the Federal Reserve would provide special financing in connection with the transaction and that the Fed had agreed to fund up to $30 billion of Bear Stearns’s “less-liquid assets.” “The past week has been an incredibly difficult time for Bear Stearns,” Alan D. Schwartz, Bear’s chief executive, said in the companies’ statement. “This transaction represents the best outcome for all of our constituencies based upon the current circumstances.”
Bear Stearns was never considered a white-shoe Wall Street firm and often operated on the edge of the industry. When the Federal Reserve helped plan a bailout in 1998 of Long Term Capital Management, the hedge fund, Bear Stearns proudly refused to join the effort. Even up until last week, Alan "Ace" Greenberg, Bear Stearn’s chairman for more than 20 years and a champion bridge player, still regaled its partners over lengthy lunches about gambling with the firm’s money in its wood-paneled dining room.
It was such gambling that eventually was Bear Stearns’s undoing. The firm’s solvency came into question late last week as clients stopped trading with it and anxiousness about its exposure to subprime mortgages spread across Wall Street. On Friday, the Federal Reserve stepped in to keep the firm afloat, extending a 28 day secured line of credit, through JPMorgan. Over the weekend, Bear Stearns, with the Federal Reserve and Treasury Department patched in by conference call from Washington, held the equivalent of a speed-dating auction, with prospective bidders holed up in a half dozen conference rooms at its Madison Avenue headquarters. While the talks were taking place, Bear Stearns was simultaneously preparing a bankruptcy filing in the event the deal had fallen through, underscoring the severity of the firm’s troubles. While the firm toyed with suitors including the big private equity firms Kohlberg Kravis Roberts & Company, which had its roots at Bear Stearns, and J.C. Flowers & Company, the only meaningful bidder was JPMorgan, headed by Mr. Dimon, who slept less than four hours the entire weekend. The deal is a major coup for Mr. Dimon, one of the shrewdest players on Wall Street. Over the last few years, focused intensely on cutting costs, improving technology, and integrating the JPMorgan’s disparate operations. But he also has been adamant about preparing the company to be financially strong in advance of a down in the economy or credit environment. That way, just as he often did with Sanford I. Weill in creating Citigroup, JPMorgan could pounce when competitors became weak.
For JPMorgan, one of the few major banks to emerge relatively unscathed from the subprime mortgage crisis, the deal provides a major entry to prime brokerage, which provides financing to hedge funds, a source of enormous growth over the past decade, but a slowing business amid the market’s turndown. Bear Stearns would also give JPMorgan a much bigger presence in the mortgage securities business, which the bank executives say they are committed in spite of them recent market downturn. There are, of course, some drawbacks to a deal, even at a bargain-basement price. Mr. Dimon has long expressed doubts that combing two big investment banks is a good idea. It is possible Mr. Dimon will shutter or try to sell that unit. Bear Stearns’s prime brokerage business would require a big technology investment. And there are often severe cultural issues and significant management overlap. With Bear Stearns, JPMorgan would also inherit a balance sheet that is packed with financial landmines, though the Federal Reserve has agreed to protect the firm from a certain amount of liabilities. Even though JPMorgan has performed well through this recent turbulence, it is unclear if it would want that additional risk. The swiftness of Mr. Dimon’s decision to buy Bear Stearns is remarkable given that he has not been an aggressive acquirer since he joined JPMorgan after selling it BankOne, which he was chief executive. He has cautioned patience about making acquisitions, though he had suggested in recent months that the firm might be ready to make a major deal.
(Facts Courtesy: The New York Times)
- Lehman Brothers
Lehman Brothers was founded in 1850 by two cotton brokers in Montgomery, Alaska. The firm moved to New York City after the Civil War and grew into one of Wall Street's investment giants. On Sept. 14, 2008, the investment bank announced that it would file for liquidation after huge losses in the mortgage market and a loss of investor confidence crippled it and it was unable to find a buyer.
Lehman's slow collapse began as the mortgage market crisis unfolded in the summer of 2007, when its stock began a steady fall from a peak of $82 a share. The fears were based on the fact that the firm was a major player in the market for subprime and prime mortgages, and that as the smallest of the major Wall Street firms, it faced a larger risk that large losses could be fatal.
As the crisis deepened in 2007 and early 2008, the storied investment bank defied expectations more than once, just it had many times before, as in 1998, when it seemed to teeter after a worldwide currency crisis, only to rebound strongly.
Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street's small fry, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy in March 2008. But by summer of 2008 the rollercoaster ride started to have more downs than ups. A series of write-offs was accompanied by new offerings to seek capital to bolster its finances.
Lehman also fought a running battle with short sellers. The company accused them of spreading rumors to drive down the stock's price; Lehman's critics responded by questioning whether the firm had come clean about the true size of its losses. As time passed and losses mounted, an increasing number of investors sided with the critics.
On June 9, 2008, Lehman announced a second-quarter loss of $2.8 billion, far higher than analysts had expected. The company said it would seek to raise $6 billion in fresh capital from investors. But those efforts faltered, and the situation grew more dire after the government on Sept. 8 announced a takeover of Fannie Mae and Freddie Mac. Lehman's stock plunged as the markets wondered whether the move to save those mortgage giants made it less likely that Lehman might be bailed out.
On Sept. 10, the investment bank said that it would spin off a majority of its remaining commercial real estate holdings into a new public company. And it confirmed plans to sell a majority of its investment management division in a move expected to generate $3 billion. It also announced an expected loss of $3.9 billion, or $5.92 a share, in the third quarter after $5.6 billion in write-downs.
By the weekend of Sept. 13-14, it was clear that it was do or die for Lehman. The Treasury had made clear that no bailout would be forthcoming. Federal officials encouraged other institutions to buy Lehman, but by the end of the weekend the two main suitors, Barclays and Bank of America, had both said no.
Lehman filed for bankruptcy Sept. 15. One day later, Barclays said it would buy Lehman's United States capital markets division for $1.75 billion, a bargain price. Nomura Holdings of Japan agreed to buy many of Lehman's assets in Europe, the Middle East and Asia. Lehman also said it would sell much of its money management business, including its prized Neuberger Berman asset management unit, to Bain Capital and Hellman & Friedman for $2.15 billion.
Lehman’s demise set off tremors throughout the financial system. The uncertainty surrounding its transactions with banks and hedge funds exacerbated a crisis of confidence. That contributed to credit markets freezing, forcing governments around the globe to take steps to try to calm panicked markets.
On Oct. 5, Richard S. Fuld Jr., Lehman’s chief executive, testified before a Congressional panel that while he took full responsibility for the debacle, he believed all his decisions “were both prudent and and appropriate” given the information at the time.
(Facts Courtesy: The New York Times)
- American Insurance Group (AIG)
Insurance Company.
- Fortis
