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Tickers in this Article: BSC, JPM, C, MS
Bear Stearns (NYSE:BSC) shares got rocked on Friday as a bailout deal showed that the investment bank's rumored weakness was all too real. The concern was that Bear Stearns had a lot of poisonous assets that it wouldn't be able to sell off. Those worries were validated when it was announced that JPMorgan (NYSE:JPM) and NY Federal Reserve had worked out a deal to increase liquidity at the beleaguered broker-dealer.

The Stock's Drop
Shares of Bear Stearns fell as much as $30 or 52% to $26.85 during trading on Friday. This is after a 7.4% decline in Thursday's trading session, and it marks the lowest point for the shares since 1998.

The drop came as news broke before the start of trading that JPMorgan and the federal Reserve worked out a deal to allow JPMorgan to bring Bear's collateral to the Fed's discount window for 28 days in a secured loan facility. Since Bear Stearns is a broker-dealer and not a depositary institution, it could not do this on its own. The Fed had implemented a new liquidity pump that broker-dealers could to take part in, but this facility does not go into effect until March 27. Bear Stearns was obviously in such a bad situation that it could not wait.

Bankruptcy may have started to self fulfill with Bear. The shares were near $160 in April of 2007 before the credit crisis started to hit. Bear Stearns was at the heart of the crisis when it became big news that two of the company's hedge funds were in trouble. (To read a detailed analysis, see Dissecting The Bear Stearns Hedge Fund Collapse.)

Other financials like Citigroup (NYSE:C) and Morgan Stanley (NYSE:MS) have dropped like rocks as well. Since the financials' fall, there have been questions whether a big-name in the market will topple as the credit markets have seized. Bear Stearns has always been one of the names mentioned, but in the last week the concerns started to grow as rumors spread that some peers started to not want to trade or do business with Bear, because of the counter-party risk. CEO Alan Schwartz went on CNBC Wednesday to say categorically that the rumors surrounding the bank's liquidity were not true. However, the rumors may have caused the problem, as just a day later the company's liquidity was completely drying up. Schwartz said in a statement Friday morning that "amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated". This meant the bank to need JPMorgan and the Fed to rescue it.

Taking On Water
Looking at the shares of the company, its book value stands at $84.03. That book value could drop considerably as more of the company's assets are revalued. On a conference call Friday, management said that the deal with JPMorgan and the Fed was to help the company maintain business as usual. I highly doubt that the book value won't fall. Bear Stearns likely won't be allowed to go bankrupt, as the Fed would not be happy with all of Bear Stearns' illiquid assets being dumped onto an already locked market. However, this deal shows that if left alone bankruptcy was a certainty. (To learn more, see An Overview Of Corporate Bankruptcy.)

It is good that the deal was worked out, but it's also very scary that it had to come to this.

The picture is still quite unclear with Bear's situation. The only plus in this is for JPMorgan. Bear Stearns also announced that, along with the secured loan facility, it is talking with JPMorgan to provide permanent financing or other alternatives. The big bank now gets to look over Bear's assets and see how much they are really worth. JPMorgan will likely try to buy all or some of the smaller bank at deeply discounted prices. As shaky as Bear Stearns looks now, there is the possibility that very soon the broker-dealer will no longer be an independent entity. The problem for JPMorgan, or any other suitor, is how nasty some of Bear's assets really could be. (For more on this analysis, check out Debt Reckoning.)

The Bottom Line
There had been rumors for a while now that Bear Stearns was in trouble. With the announcement of the secured loan facility worked out with JPMorgan and the NY Fed, it's clear the rumors are very real. The outlook is bearish for Bear, but this deal could work out well for JPMorgan. The big bank can now thumb through Bear's books closely, and might choose to pick up parts or the whole company at very steep discounts.

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