So, those liquidity rumors? Turns out they were true – or, at the very least, self-fulfilling. The official statement from Bear Stearns CEO Alan Schwartz:
Bear Stearns has been the subject of a multitude of market rumors regarding our liquidity. We have tried to confront and dispel these rumors and parse fact from fiction.
Amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated. We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations.
The attempt to prop up Bear is interesting: basically, the Fed is lending money to JP Morgan, who in turn is lending money to Bear Stearns. JP Morgan Chase is a commercial bank (Chase Manhattan), which gives it access to Fed facilities investment banks don’t get to use. But it certainly looks as though JP Morgan is taking on Bear Stearns credit risk, despite its statement that "it does not believe this transaction exposes its shareholders to any material risk."
(Update: according to Barry Ritholtz’s excellent liveblog of the Bear meltdown, in fact it’s the Fed, and not JPM, which is taking on the Bear credit risk.)
Why couldn’t Bear use the Fed’s brand-spanking-new TLSF, which is open to investment banks? Because it’s not active yet: it doesn’t go live until March 27.
Shareholders in Bear Stearns are far from reassured: the stock is plunging today, last seen below the $40 level. (Update: Now below $30.) Clearly the market thinks the problems are bigger than mere illiquidity: they’re worried about Bear’s solvency. As a commenter wrote here yesterday, if Carlyle Capital can be wiped out, so can Bear. While Carlyle’s leverage was enormous at 32x, Bear’s is actually even larger, at 33x. And that’s valuing Bear’s assets as of the end of 2007; those assets have surely deteriorated in value since then.
So make no mistake: Bear’s very survival is on the line here. Bear is a large Carlyle creditor, to the tune of $1.7 billion: that can hardly help either its liquidity or its solvency. But it’s not curtains for the bank quite yet, says Richard Beales of Breaking Views:
Bear is, of course, much bigger, its assets and revenue sources are more diverse, and its financing is not as concentrated in short-term repurchase arrangements. That makes it much less vulnerable even if creditors suddenly demand more collateral – the margin calls that exhausted Carlyle Capital’s limited supply of cash.
But Bear’s relatively small size and its focus on the US mortgage market – where the rot that began in subprime loans is now permeating even the safest loans – makes it an obvious early target for other banks’ repo desks and credit committees bent on cutting credit exposures across the board, and consequently for investor concerns.
The market is a brutal place, and once the sharks smell blood, that’s often the beginning of the end. This is the right time for a deep-pocketed savior to swoop in and buy up one of the most storied names in investment banking on the cheap: unless it has a creditworthy parent, it’s hard to see how Bear Stearns can operate as a bank when no one really believes in its credit.
In the absence of such a white knight (a/k/a the "strategic alternatives" that Schwartz is talking about), the immediate future for Bear seems fraught. That said, however, Bear’s credit default swaps have actually tightened this morning, by about 150bp. That could be because of the credit line, it could be "profit taking". My guess is that the credit markets are happy to see the equity taking the first and most serious blow. The Fed is likely to ensure that Bear’s creditors get paid in full; it has no interest in protecting Bear’s shareholders.