Allan Young’s Incoherence

A few days ago, I remarked how precariously positioned the investment banks had become. Today, we witnessed something spectacular as these once proud institutions accelerated their fall. Bear Stearns (BSC) will be taken over in a fire sale for approximately $2 per share by JPMorgan Chase & Co. (JPM) with backing from the Federal Reserve. Lehman Brothers (LEH), which has a similar business model to Bear, saw its stock take a dive on fear that it too faces liquidity problems.

Yesterday, Fed chair Ben Bernanke took the unusual step of lowering rates and extending loans to investment banks only two days ahead of the regularly scheduled Fed meeting. The high priests of the central banking system are in full panic mode now and I suspect them to lower a key interest rate by at least 75 basis points and probably by 100 basis points. If Bernanke & Company are going to try and avert financial disaster, they may as well take bold steps. The market will most certainly react very negatively to an interest rate cut of less than 75 basis points.

Does the Bear Stearns buyout make it an interesting speculative short, even this late in the game? JPM’s acquisition price of $2 per share is much less than today’s closing price of $4.81 per share in BSC. Large shareholders of BSC will no doubt revolt at the $2 liquidation price tag but there aren’t many options left on the table. Without a buyer, BSC will likely declare bankruptcy and there aren’t many other banks around with the support of the Fed underwriting the first $30 billion in risk on the BSC balance sheet.

In the aftermath of this debacle (whenever that may be), many value investors will attempt to pick the good apples off the ground while leaving the bruised ones to rot by the tree. Mostly prudently run ibanks like Goldman Sachs (GS) will need a good dusting off, but will be relative bargains worthy of inclusion in a value portfolio. Note, even the mighty Goldman is rumored to be gearing for a $3 billion writedown when it reports earnings Tuesday. I suspect that Merrill Lynch (MER), whose business model is most unlike the Bears and Lehmans of the world, will weather this storm and come out much weaker but capable of recovery.

The really big question: Does Mr. Bernanke have enough firepower and “influence capital” left to avert another disaster if Lehman becomes the next casualty? At the very least, he has proven himself unafraid to take drastic measures.

Categories: Investing
Tags: Bear Stearns, Ben Bernanke, BSC, buyouts, Federal Reserve, Goldman Sachs, GS, interest rates, investment banking, JPM, JPMorgan Chase & Company, LEH, Lehman Brothers, liquidity, MER, Merrill Lynch, value investors, writedowns