Why JP Morgan Did It Leverage Loans and Client Exposure To Shaky Financial Instruments Held By Bear Gave JP Morgan Strong Incentives To Rescue Bear’s Portfolio

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Bankers at JP Morgan Chase sounded very confident that their shareholders would approve the deal to buy Bear Stearns. Speaking on a conference call with analysts and investors, JP Morgan chief financial officer Michael Cavanaugh repeatedly told questioners that he believed the deal would benefit JP Morgan and meet with shareholder approval. Clearly the low price—and lack of other bidders who could secure the kind of fire-proof financing from the Federal Reserve—encouraged JP Morgan to do the deal. But the price to JP Morgan far exceeds the purchase price thanks to the guarantee extended to Bear Stearns counterparties and clients. Last night, JP Morgan estimated deal costs could reach $6 billion.
Sources close to the deal say JP Morgan found the deal—even at that elevated cost—attractive in part because the potential fall-out from a Bear Stearns bankruptcy would have had a serious negative impact of JP Morgan’s balance sheet, both through its direct exposure to leveraged loans, mortgages and mortgage based securities and through exposure of JP Morgan clients who are counterparties in Bear Stearns positions.
A fire-sale of Bear Stearns assets—or a lock-up of the assets in bankruptcy proceedings—would have seriously damaged JP Morgan’s balance sheets and those of its clients. Many clients have direct exposure to Bear Stearns through various trades, and a bankruptcy would have forced them to cut-back elsewhere—including deals in which JP Morgan seeks to participate. JP Morgan holds hundreds of millions in leveraged loans and loan commitments, which may have suffered if a Bear Stearns bankruptcy had worsened the credit crunch. Exact numbers, or even estimated losses, were not made available to DealBreaker.
“People compare this to JP Morgan himself bailing out the NYSE, and that’s exactly right. It’s just that both are different than people think. Neither was a work of charity. It was self-interest all the way,” said a senior banker close to the deal.
"People who want to call this a bailout should think about how the ripples from Bear going under could have become a rogue wave flooding places with leveraged balance sheets, even those as well-situated as JP Morgan," another banker who was working Sunday night said.
The market seemed to appreciate that this deal lowers "ripple effect" risk to JP Morgan, sending shares higher. The move surprised many market-watchers. The share price of buyers typically moves down after a major M&A deal is announced. Here, however, investors seem to understand the logic behind this as a risk-averting deal.