Novice Investing - Bear Stearns Provokes Bear Reaction

Date: Friday 09th 2008f May 2008 03:28:18 PM

Bear Stearns Provokes Bear Reaction - 03/15/2008

By: Hari Wibowo

Bear Stearns Inc. (BSC) get on the panic mode Friday 14th March with the announcement that JP Morgan Chase and New York Federal Reserve had stepped in to provide temporary funding for the investment bank. While rumor persisted several times this week, Bear Stearns CEO, Alan Schwartz, came out on Wednesday afternoon to reassure Bear Stearns' position with its $ 8.2 Billion net cash position and $ 17 Billion in short-term capital available.

It turns out now that the rumor has been more true than what Bear Stearns' management would know. Did they hide something? Well, actually, management's job is to defuse any panic concerning the company. If Mr. Schwartz admitted Bear Stearns' precarious position earlier in the week, Bear Stearns may be in a more dangerous positions now because as you know panic always feed in itself.

Both JP Morgan Chase and New York Federal Reserve bank did not disclose the amount of the cash infusion. But, we can only make a guess. Fortune wrote that Bear has difficulty of renewing $ 102 Billion worth of open repurchase agreement. Therefore, if we assume that the Bear Stearns' bailout is worth $ 102 Billion, is this a reasonable guess? Let's take a dive into it. If you look at Bear Stearns' balance sheet from Yahoo! Finance, you can see that the difference of its long term investment ($ 269 Billion) with its long term debt ($ 131 Billion) and short term debt ($ 158 Billion).

Long term Investment - Long Term Debt - Short Term Debt =
$ 269 Billion - $ 131 Billion - $ 158 Billion = - $ 20 Billion

This deficit of $ 20 Billion is what Bear Stearns need when investors panic and demand their money back immediately. Remember that most financial institutions thrive by taking in investors' money/ deposit or whatever it is (short term debt) and lend it to other institutions (long term investment). So, is that it? Not so fast. Most creditors would want their money now sooner too. Therefore, we have to presume that creditors are asking their $ 90.2 Billion worth of accounts payable in the balance sheet. For this purpose we have to match Bear Stearn's cash on hand with its accounts payable.

Cash & Equivalents + Short Term Investments - Accounts Payable =

$ 34.3 Billion + $ 27.9 Billion - $ 90.3 Billion = - $ 28.1 Billion

In this case, you would add in total deficit and provision fund (let's say +/-5 Billion) and we came up with total bailout package of $ 53.1 Billion. How does that compare with previous bailout such as Long Term Capital Management in 1998? A brief history of Long Term Capital Management. In the beginning of 1998, Long Term Capital Management had borrowed $ 124.5 Billion with $ 4.72 Billion in equity. During May and June of 1998, at the height of Asian Financial Crisis, Long Term Capital Management spotted a return of -6.42% and -10.14% respectively. Thereby, it reduces its equity to a dangerously low level of $ 461 Million. Immediately, Federal Reserve Bank of New York (sounds familiar ??) organized a $ 3.65 Billion bailout to prevent further collapse.

While terms of the Bear Stearns' bailout was not disclosed, the size of it would be in the tens of billions of dollars. For now, nobody can make good prediction on how much it would cost to save Bear Stearns. It just depends on the level of the panic that we are in. But, if investors really does not have any faith in the US financial system, ultimately JP Morgan Chase would have to pour in the amount that Bear Stearns owed, which is roughly $ 53.1 Billion. How is that for the cost of saving the US financial system?

As for Bear Stearns stock, there is no telling how low or how high it would go. This is purely speculation at this point. In normal circumstances, a stock that fall 40% in one single day like Bear Stearns would catch our attention. However, in this case, it is better if we invest in other financials that are dragged down by this news.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Bear Stearns Inc. (BSC) or any other securities.

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