PETER R. MACK & CO. INC.
MEMBER FINRA/SIPC
19 EAST 71ST STREET, SUITE 3
NEW YORK, NY 10021
TEL: (212) 744-3939 FAX (212) 744-8484
E-MAIL: PRMCO@AOL.COM
March 16, 2008
9:15PM
J.P. Morgan earlier this evening announced the acquisition (bailout) of Bear, Stearns (BSC) in a stock transaction valued at around $2.00 in JP Morgan (JPM) stock based on today’s prices.
Tomorrow’s market prices may be lower.
This is a dramatic reversal of fortune for Bear, whose shares traded as high as $160 per share in 2007, and just last Friday closed at $30 after trading as high as $60. This is a tragedy for all Bear employees whose net worth after long careers was tied up in shares and pension plans now rendered just about worthless. Bear was known as a very aggressive firm, and in some ways, not in the “club.” In 1998, when other firms headed by Goldman Sachs (GS) put together a consortium to advance capital and bail out the failed hedge fund Long Term Capital Management, Bear generated some enmity by declining to participate. As a leader in the underwriting, generating, and marketing of mortgage obligations of all types, Bear undoubtedly is carrying large, heavily -margined positions which have no liquidity and have lost a great deal of value, rendering them unable to raise additional cash. In addition, as word spread last week of their difficulties, other firms stopped trading with them, concerned that they would be unable to complete and honor the trades. It was almost inevitable that they would be sold or gone bankrupt, although a $2 per share price, representing a $236 million equity value seems pretty low.
It’s probably hard to generate a lot of sympathy for Bear because of the impact its behavior has had on the markets and all of our portfolios, but it is a human tragedy. There is another major investment bank – one that’s in the club - rumored to be in trouble because of an over-levered balance sheet, but that situation may be resolved in the next week.
Last week, the business media ran with the story of the failure of an investment fund called Carlyle Capital as it failed to meet margin calls. According to reports, Carlyle, with equity of around $690 million, was holding mortgage bonds bought on margin worth about $22 billion. Just for an example, a portfolio of that size that goes down about 5% loses $1.1 billion, wiping out the equity that existed. Figure out that a 10% drop loses $2.2 billion and nobody seems to have any idea what all these bonds floating around are worth.
It should be noted that equities (stocks) are purchased on 50% margin as they are perceived to be riskier than bonds. Not always the case, it seems.
Along with the merger of BSC and JPM, in which the Fed is indemnifying some (maybe all) of JPM’s assumed liabilities, the Fed also announced a cut in the Discount rate effective tomorrow, and an expansion of its lending on mortgage instruments classifying many of the issues as acceptable collateral. I anticipate a further significant reduction in the Federal Funds rate at the Fed meeting later this week. The banks are capital-short so rate reductions may not be immediately be passed on to customers, but the Fed is clearly showing a determination to flood the market with low cost paper to ease mortgages and ease the current crisis of confidence.
Should the dollar continue to weaken, I would expect a Treasury intervention to support the dollar, although it may have more of a psychological effect than an actual impact on dollar rates. Just today, Secretary of the Treasury Paulson said in a speech that the United States favors a strong dollar, even though the dollar has been plunging to record lows against the Euro without any word. Today’s words must be interpreted as a strong signal.
I believe that Congress will shortly enact legislation to expand the limits on FHA mortgages from $417,000 to significantly higher levels ($700,000 plus) and probably legislate the expansion of the lending ability of Fannie Mae and Freddy Mac mortgage lending institutions.
Add in the publicized problems involving Auction Rate Securities, rising energy and commodity prices, zooming health care costs – Oxford just raised our premium for the company’s health insurance by 17.5% - and low returns on investments and people are suffering.
On the other hand, stocks are relatively cheap, especially against a backdrop of declining interest rates and, believe it or not, the national foreclosure rate on housing as a percentage of mortgages outstanding is at manageable levels, with certain states holding and others in trouble. Without direct knowledge it is difficult to know what’s happening, however, it is probable that many of these mortgage bonds being marked-to-market are still collecting interest and principal payments and still represent viable investments. The main issue is determining what others will pay for them – i.e. their value as saleable assets – rather than on the long-term value as an income-producing investment.
We are in a crisis of confidence and there is no telling when it will be resolved. In the meantime, every media source is proclaiming the end of the financial world and people are really starting to get scared. It is very clear that the Federal Reserve and the U.S. Government seem finally ready to pull out all the stops and provide liquidity to the strapped fixed income markets.
Neither Peter R. Mack &
Co., Inc nor its principals have any investment positions in any securities
mentioned herein Furthemorer, the Firm makes no representations as to the
accuracy of any information or statements contained herein and the reader
should not rely on these statements for any purposes.
