Andrew Sorkin: Fed strong-armed Bear deal with deception, rule breaking

The Hand Behind the Deal

By Andrew Ross Sorkin
The New York Times
Tuesday, March 25, 2008

http://dealbook.blogs.nytimes.com/2008/03/25/ben-bernanke-deal-maker/

Adam Smith's invisible hand has a puppeteer: the Federal Reserve.

In case there is any confusion about who was pulling the strings behind the scenes of JPMorgan Chase's acquisition of Bear Stearns, the curtain was lifted Monday. By raising its bid -- with the grudging approval of the Fed -- to $10 a share, from $2, JPMorgan exposed what had long been whispered about but no one dared to say aloud: The Fed is officially in the deal-making business.

There's been a lot of debate about the price that JPMorgan originally offered for Bear -- a price that even Jamie Dimon, JPMorgan's chief executive, suggested on Monday was unfairly low. That, of course, was after he told Bear employees only days earlier, "I feel terrible sometimes when people think we took advantage."

So where did the guidance for that price come from? You guessed it: Ben S. Bernanke, the Fed chairman, and his teammate, Henry M. Paulson Jr., Treasury secretary, were calling the audibles in the boardroom. Timothy F. Geithner, the president of the Federal Reserve of New York, also was calling some last-minute plays.

Christopher Whalen, managing director of Institutional Risk Analytics, put it bluntly: "Even at $10 per share, the JPM buyout stinks to high heaven because of the conflicted role played by the Fed."

The Fed continues to maintain that it did not set the original $2-a-share price that JPMorgan was to pay for Bear. Fed officials said they didn’t care what the price was; that’s not their business, they said.

At the same time, the Fed felt that Bear was headed toward imminent bankruptcy, in which shareholders would be wiped out. Any bailout needed to be for the overall system, and not for Bear shareholders -- the "moral hazard" issue writ large.

One official close to the Fed said that Bear executives themselves did not seem to realize that they had no choice other than a bankruptcy filing. Part of the shock over the price, he said, "was that so many people hadn't figured out the reality."

And the Fed is in the business of saving the financial system from evil, not saving fat cats from having to sell their wine collections, as one Bear executive apparently did last week.

Perhaps the Fed never set the exact price, but the notion that it didn't press JPMorgan to pay as close to zero as possible doesn't square with reality.

One clue came after the $2-a-share deal was announced, when Mr. Paulson told Matt Lauer of "The Today Show" on NBC: "Let me say that the Bear Stearns situation has been very painful for the Bear Stearns shareholders" -- as if to suggest that Bear's shareholders still were losing their shirts and that was a good thing. The bailout was for the American people.

Mr. Paulson was desperate to demonstrate to Main Street that he wouldn't rescue Wall Street on the government's dime, even though that's exactly what he did, by providing a $30 billion backstop to the deal. (And he may have been right to do so.)

But the night that Bear signed the original bid, the Fed opened what's known as the discount window to companies like Goldman Sachs and Lehman Brothers -- oh, yes, and to Bear too. Except that the Fed didn't tell Bear that it planned to open the window when it was signing its deal with JPMorgan.

Had Bear known that it might have access to the discount window -- a crucial source of liquidity -- it might have been able to hold out for a couple more days or at least had enough leverage to seek a higher bid. But the Fed clearly preferred the original bid.

Inside Bear, jaws dropped at what many considered a broad deception by the Fed. Alan D. Schwartz, Bear's chief executive, was furious, as was the board and its team of advisers. Several JPMorgan executives even offered their apologies about the way the deal "went down."

Of course, shareholders were even more irate, describing the deal in unprintable terms. In effect, they revolted against the terms of the deal -- and both JPMorgan and the Fed wound up having to mollify them by raising the price.

Had the deal died, Bear would once again be risking bankruptcy, and the market would once again be risking turmoil. (Bear shareholders seem to think they still might have another chance, though, bidding its shares on Monday up to $11.26.)

Still, the Fed almost derailed the $10-a-share agreement. Just as JPMorgan and Bear were about to consummate the deal on Sunday night, the Fed started raising questions about the price, people involved in the discussions said. The deal makers were forced to delay announcing the deal until Monday morning while the Fed hashed through "the optics" of the deal, as one participant described it.

The truth is that the Fed preferred the $2 price because of the obvious message it sent to the rest of the market, but in the end it went along with the new agreement, in part because it worried that failure of the deal might overwhelm the markets. And they got a giveback -- JPMorgan is on the hook for the first $1 billion in losses.

Even then, the Fed's fingerprints were all over the new pact. In an action almost unprecedented in takeover history, JPMorgan bought 39.5 percent of Bear on the spot to ensure that it would have close to a majority of the votes to approve the deal. That agreement completely disregards New York Stock Exchange's rules that prevent anyone from buying more than 20 percent of company without a shareholder vote. Other parts of the new agreement either stretch the rules or disregard years of precedent in Delaware, where both banks are incorporated.

Of course, all this rule-bending was done with the tacit, if not outright, approval of the federal government.

If that's not deal-making, Fed-style, what is?

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Andrew Ross Sorkin is "DealBook" columnist for The New York Times.

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