JP Morgan and Bear Stearns Essay

BackgroundIn the last three decades, the US banking constitution has changed its enthronisation procedures and its try management collect to changes in government regulation. Furthermore, external shocks, such(prenominal) as the ostentationary period during the 70s and the receding in the 80s, led Banking institutions to alternative ways of enthronement in pose to bide profitable. The average annual inflation stride from 1900 to 1970 was approximately 2.5%. From 1970, however, the average range nominate ab place 6%, topping out at 13.3% by 1979. This period is besides agnizen for stagflation, a phenomenon in which inflation and unemployment steadily increased. A loose financial policy led to very low-spirited interest rates. Corporations were latch oning large amounts to finance leverage buyouts (LBOs), which led to eminenter and high interest burden. One of the master(prenominal) instruments utilize was financial derivatives, which gave Banks additional pro fit. Moreover, this instruments equal t onlyy oddment sheet activities, thus dowry bank capital.Nonetheless, these instruments were bumpy and could led to grand losings. In the late 70s and early 80s precept the rise of a lean of financial products such as derivatives, high flag an structured products, which provided lucrative returns for investiture banks. excessively in the late 1970s, the facilitation of corporate mergers was universe hailed as the last gold mine by investment bankers who assumed that Glass-Steagall would someday collapse. At this time we could take up the source efforts to loosen Glass-Steagall restrictions and some brokerage devoteds stimulate encroaching on banking territory by leading money-market accounts that pay interest, allow check-writing, and offer credit or debit cards. Moreover, in 1974 NOW (Negotiable Order of Withdrawal) accounts were created by a small bank in Massach intenttts, religious offering negotiable orders of withdrawa l to permit payments on near-checking accounts at banks. In 1980, they were permitted for all institutions, with rate ceilings eliminated in 1986. back up Sterns and crisisAs an investment bank, rear Stearns & Co. had three master(prenominal) operate handicraftes. The first one was cracking Markets, which include brokerage services, market- devising and proprietary transaction in both equities and fixed income. Moreover, this bang-up Markets business also include investment banking services such as securities progeny and advice on mergers and acquisitions. Its fixed income business represented the highest contribution to its revenue. The second operating business was Global Clearing Services which included the corporations well-regarded prime brokerage business. devote Stearns provided trade execution and securities clearing, custody, contribute and financing to hedge funds and broker-dealers as a prime broker. The third operating business was Wealth Management whi ch included deals Private customer Services group, which served high-net worth individuals, and back Stearns asset Management, which managed hedge funds and former(a) investment vehicles.Bear Stearns & Co. was an investment bank, a financial intermediary that performed a variation of services. As an investment bank it specialise in large and complex financial transactions. Its primary regulator was the Securities and Exchange missionary work and did not imbibe devil to the federal Reserve discount window, which allows eligible institutions to borrow money from the central bank, usually on a myopic-term basis, to meet temporary shortages of liquid state caused by internal or external disruptions unlike moneymaking(prenominal)-grade banks. The main difference between a mercenary bank and an investment bank such as Bear Stearns was that firearm commercialised banking involved both taking deposits and making loans that remained on the lenders equilibrise sheet, inv estment banking involved the underwriting of debt and justness securities, get them from the issuer typically with a syndicate of otherwise firms and then selling them on to investors. umpteen years ago it was difficult to avow whether a bank engaged in commercial activities or investment activities, however, the telling prohibited investment banking and commercial banking in the same firm in 1993. unless 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 enter the commercial banking business so as a case they did not have access to the Federal Reserve discount window. cater Chairman Christopher coxswain said that Bear Stearns was sufficiently capitalized at all time but facing skeptical lawmakers, Cox acknowledged that the firm had big liquidity problems and that capital is not synonymous with liquidity. He said the SEC is working with t he louvre biggest Wall Street firms to make veritable they increase their liquidity pools and redouble their stress on risk practices. On parade 13, he indicated that liquidity at Bear Stearns fell from $12.4 million to $2 billion because of the complete evaporation of confidence in the accompany.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 necessitateed a well-capitalized as a firm with a healthy liquidity status. From our point 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 too fatal and governments would be hale to intervene and rescue them in order to keep the economy from collapsing. This is the reason wherefore the term to big to fail arose. In spite of this, as Nassim Nicholas Taleb said, we coul d face a black swan case, which refers to an event, absolute or negative, that is deemed improbable yet causes massive consequences. Bears activities were financed with a intermixture of long term debt, justice, and financing collateralized with securities from Bears entry.Besides this, Bears trading business required 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 goat slow see that those companies had much more tilt in liquidity than Bear Stearns. It was down the stairs those three in repo financing and repo change too. Specifically, Merrill Lynch had sum total liquidity of 181.9 while Bearn Stearns had 35.3 and total liquidity as dower of repo financing was 77% in Merrill and 345 in Bearn Stearns. Bear Stearns nearly colla psed not one time but twice before the cash-strapped brokerage firm was rescued.The leverage suffered by Bear Stearns at that time increased the risk of becoming bankrupt. This was because, with a big leverage, losses are larger and can pull down the firms entire equity to the point where the book order of the company is zero or even negative. In the worst case scenario, Bearn Stearns, being likeness for many repo agreements and other financial instruments could result in default on their payments, which is why it ended up being rescued. By knowing this facts we can tell that the firms value would indeed be negatively affected by a potential bankruptcy.ValuationTo give a price to pay for Bear Stearns ongoing businesses we have to use a military rating method. Being unable to perform an adequate due(p) diligence we are not going to be able to know the actual risk of many of the assets, and and then unable to use the real value. For this reason, the valuation method we are goin g to use is the Book evaluate per Share, which by commentary indicates the remaining value of a company for its shareholders, should it dissolve, which is quite similar to the process Bear Stearns is going through. To meet the book value, we have to chance upon the total shareholder equity and figure from it all preferred equity. In order to do so, we have to take a look 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 ocellus, which is $352 million. 11544 Doing so we obtain a value of $11,544 million, which divided by the function of total shares outstanding should give us the book value per share of the company. flavour 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 i ssued as of November 30, 2007 and 2006. We can see it bring out this wayNov. 30, 2007Nov. 30, 2006Authorized500,000,000500,000,000Issued184,805,847184,805,847This 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 previously 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 means that the company has bought, in total, 139,204,103 shares. Subtracting the value 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 closelipped to the price JP Morgan ended up paying. However, I would say this value is too high, due to the great amount of uncertainty regarding the interpretation of Bear Stearns to the MBS market and the great illiquid ity risk it is facing.