The RIch Get Richer

Bear Stearns CEO, James Cayne, made over $50 million today thanks to the Federal Reserve guaranteeing Bear Stearns losses with taxpayer money.

You might recall that Bear Stearns, whose investment strategy resulted in mortgage hedge funds it ran liquidating leading to a loss of investor confidence and a stock price meltdown from over $150 per share to $30 per share on March 13. Over the weekend of March 14 and 15, the Federal Reserve blessed a buyout of Bear Sterns by JP Morgan for $2 per share on March 16.

The deal allowed Bear Stearns bondholders to avoid losses as a result of pending bankruptcy even though shareholders got hurt. Since the bulk of Bear Stearns shareholders were their own partners it was argued that the financial pain for their poor decisions was justified.

The kicker was that the Federal Reserve would guarantee the first $30 billion of Bear Stearns losses. That's right, JP Morgan bought Bear only on the condition that the Fed would cover potential losses up to $30 billion of, I assume, taxpayer money.

This week, shareholders of Bear Stearns didn't like the deal. They wanted more money even though they made risky decisions and helped wreck the economy. So today, JP Morgan agreed to pay shareholders of Bear $10 per share. The Fed decided as a result that JP Morgan would now have to cover the first $1 billion of Bear losses and we would cover the remaining $29 billion.

Now it is bad enough that taxpayers are 1) helping bondholders who bear the risk of investing in Bear bonds; 2) subsidizing JP Morgan in purchasing potential tangible assets that will eventually be valued far above the purchase price; and 3) setting a precedent for future monetary handouts to Wall Street plutocrats to continue playing bridge and smoking dope at country clubs.

But, the deal today adds insult to injury. Assuming the market correctly priced Bear at $30 per share on March 13. The Fed's deal to allow JP Morgan to buy Bear for $2 per share guarantees $30 billion in losses. JP increased its payment to Bear by $8 per share. Why should the Fed only require JP Morgan to assume the first billion in losses? If they got that deal for every extra $8 it paid, the Fed would guarantee approximately $24 billion at the $30 per share price - - which it would not and did not do.

If there is going to be a bailout there has to be some disincentive to moral hazard both past and future. If the Fed is going to allow Bear shareholders and its partners to get more money from JP then they should put the risk of losses on JP Morgan. This deal is about as bad as you can get for those not employed by investment banks. If $12 million was not enough for James Cayne to walk away from the financial ruin he presided over, then let him walk away with nothing. Let Bear fail and use the $30 billion for main street recovery.