United Status of America was the dream destination for many for few decades. However, things dramatically changed as we entered in the calendar year 2008. The older problems like terrorism are still haunting and the new demons like rising inflation, sub prime mess, depreciating currency and a risk of deflation have come to fore. The impact is seen across the length and breadth of USA, and tremors are still being experienced in the places like India. In the same context, the fall of Bear Stearns is a classic case study.
Bear Stearns was one of the big Five investment banking firm, offering securities and derivatives broking, asset management, clearance services. As of November 30, 2006, the company had USD 52.5 billion worth of assets under management. Bear Stearns had a significant exposure to the asset backed securities. In the normal circumstances the asset backed securities are treated to be the safest instruments in the markets as the holders can sell of the assets and recover money in case of defaults by the borrowers.
Bu the things this time turned for bad. The US experienced rising interest rates over the five years starting from 2002. Simultaneously the economy was slowing down. The jobs were cut and transferred to the emerging economies. Job losses and rising interest burdens made the borrowers of the properties to default. Especially the home loan market suffered like anything. The demand for new houses was falling continuously and there is a supply rise from the re-sale house market. Demand weakening and supply strengthening obviously resulted into the fall in house properties' prices. This culminated in the falling prices of asset backed securities as a perception was built wherein the investors doubted the capital safety. Marked to market losses on these securities made the income statement look ugly.
There was another time-bomb ticking in the books of the company. The credit default swaps. It is an instrument wherein the issuer agrees to make good the losses of the buyer if a third party defaults on a debt instrument. As the economy slowed down and the defaults rose, the buyers of the credit default swaps stood in a queue at the doors of Bear Stearns. This acted as a further leg puller of the company impacting profits significantly. The investors and bond holders of this company decided to pull out.
Like any other financial institution the company has financed its long term obligations with the short term deposits. The asset liability management became tougher as the depositors decided to pull out. It turn out to be a 'classic run on bank' creating a risk of existence. The stock market sensed this well in advance. The stock nosedived from USD 100 to USD 30 in less than two months.
A firm of the stature of Bear Stearn when collapse, takes many more with it due to the complex financial transactions and the interdependence. The Federal Reserve could not afford this happen. But a bailout would have amounted to ignoring the mistakes of the management of this company. The Fed played a smart move. It offered a credit window of USD 30 billion to JP Morgan and induced them to buy out the ailing institution at two dollar per share.
This ensured two things. First it ensured that the business of Bear Stearns will remain. The promises made by this dying organisation will be kept. And on the other hand the management stake in the company will turn out to be negligible.
However like any other time, the market turned out to be smarter. The two dollar a piece offer valued the whole company for USD 287 million which was nothing but a song. The headquarter building of this company was valued at USD 1 billion. The market valued the stock at USD 5 each. And the market was proved right again, as JP Morgan raised the price five times to USD 10 each share.
This opened the battle between the management of Bear Stearns and the JP Morgan for controlling the business. Like any other management the management of Bear Stearns is keen not to allow the business to be sold at song. The shareholder meeting will be the battleground which will be kept sometime in the month of May. Both the parties are augmenting their resources to prove their majority. However a third segment has become active. The bondholders of Bear Stearns are augmenting the shares of the company, as they think that JP Morgan is better placed than Bear Stearns to honour the bonds. This is surely a good news for JP Morgan. However only the time will tell who will remain.
In the meantime JP Morgan is busy de-leveraging the balance sheet of Bear Stearns. This will ensure that if the bid goes through they will get a good business at good price. And if they do not succeed, then the sinking of Bear Stearns will not create much of earth shattering waves. Fed is better off in both the cases. In India we have not seen such corporate wars for some time now, barring few instances few years back.
The de-leveraging activity mentioned above however created many problems, that most probably even the JP Morgan would not have thought about. The one day sale of Rs 1300 crore worth of Indian shares and securities in Indian markets have taken many for a joyride. One of them is Rao, the promoter of Orchid Chemicals with approximately 17% shares. The fall in the share price of Orchid, due to sale by Bear Stearns, have triggered the margin call for the promoter who happened to bought the shares in futures. As he could not pay in time, the brokerages sold off, further dampening the share price. This was a big blow. In the meantime, Solrax Pharma, the pharma behemoth Ranbaxi's associate, purchased more than 10% of the Orchid shares at a throw away price. Now there is a hostile takeover possibility of this company. There is lot to unfold. But one thing is for sure, most of the Indian investors got to know, one more possible impact of globalisation..
Source: UMCapital India |
