JPMorgan Chase Buys Bear Stearns for $2 per Share and the Fed Cuts the Discount Rate

Usually the economic news is relatively light on the weekends, but this weekend has been filled with news. Most notably is the news that JPMorgan Chase is buying Bear Stearns for a mere $236 million. This is significant when you consider that just last year, their stock was trading for around $150 per share, giving Bear Stearns a market cap of over $18 billion.

The shares have been declining since last summer, and BSC has dropped from $150 to a measly $2 at the buyout. When you think about the ability of a company worth tens of billions of dollars to become almost worthless in a matter of months, you have to be slightly concerned that this could happen to more companies as well.

Analysts argue that a a complete collapse of Bear Stearns would have virtually destroyed any lingering confidence in the financial markets, but I think the damage has already been done, whether Bear Stearns went bankrupt or not. The simple fact that this company has gone from one of the biggest investment firms on Wall St. to the equivalent of a penny stock will shake any confidence that was left, regardless of being saved from bankruptcy by another firm.

The Fed Takes Action

In an attempt to ease this situation, the Fed cut the discount institutional lending rate from 3.5% to 3.25%. This may be appropriate action, but the markets have not responded positively to the news. This small drop in rates has little effect when the U.S. dollar continues to fall and oil prices continue to set new records.

Where Are We Headed?

Things aren’t looking good, but where do we stand in the big picture? Well, even with a poor start to the year where the S&P 500 is down around 12%, we have to look back at the years prior to put things into perspective. If we look back at the S&P starting in 2003, it has returned 28.5%, 10.7%, 4.8%, 15.6% and 5.4% in 2007. So over the past five years, most people who are invested primarily in equities have probably seen somewhere between a 40-70% total return. This puts the 5-year annualized return somewhere around 12%, which is a tad higher than the long-term historical average of the stock market.

That being said, it makes the 10-20% losses that most people have seen in the past six months not seem quite as bad. Of course, when you lose that much in such a short period of time and only see your quarterly statements, it can seem a bit rough, but you have to keep in mind that these same investments were doing fantastic over the previous five years, so it isn’t the end of the world.

Of course, we don’t know how long this will last, or how bad the losses will be. Some have said that we’re approaching the bottom of the housing market, while others are still saying we’re in for a nasty recession. It is impossible to know who to believe, and to try and shuffle your asset allocation around in reaction to what has already happened in the market is a dangerous game. Develop a portfolio that suits your time horizon, investment objectives, and risk tolerance, and consistently add to your investments over time. You will be rewarded, even if it doesn’t seem like it right now.

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Filed Under: Economy

About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

3 comments
Frugal Dad
Frugal Dad

I feel sorry for the thousands of Bear Sterns employees (well, many ex-employees now) who were stuck holding a bag of rapidly declining retirement portfolios. Just another reason to diversify, diversify, diversify!

Jen
Jen

This whole debacle has just been bizarre.... It's like a Moment of Zen. Especially when I hear the news first thing in the morning, when I'm not quite awake ;)

For my own investments, I put my money in index funds, or funds of index funds. I might be a smidge too light in the bond funds, so I am considering changing my 401(k) contributions to put more money in bonds and a little less in stocks, but I don't see that as an urgent matter. Then again, the overall value of the stock funds may have fallen enough that my asset allocation is on target ;P

My bigger concern is that people will continue to panic and make a bad situation worse.

Lily
Lily

I think I read that the Fed has also increased the discount window to 90 days, which means bank borrowers have 3x as much time to pay back the Fed. This news is also not really bolstering the market, but it shows a willingness for the Fed to take extraordinary steps to intervene.

Whether this is a good thing, I'm not sure. A lot of people have been blasting Bernanke as a Wall Street crony, and his action certainly speaks to this image. Providing JPM support in its ridiculous bargain-basement purchase of Bear? Opening its coffers to investment banks?

I find it hard to criticize Bernanke. I can see where recent Fed actions have (1) not improved liquidity or market conditions and (2) greatly increased the risk of higher inflation. But on the other hand, I can't say with any degree of certainty that the alternative (not lowering rates, not taking measures to bail out banks) would be much better. For all I know, that would have meant a run on ALL banks, not just Bear, and a collapse of our economic structure (rather than the mild correction/recession that a lot of Fed-critics suppose).

I'm still steadily funneling my money into retirement accounts. It's a rough time to enter the market as a recent college grad, but hopefully I'll forget all about this turmoil in a decade or two. Meanwhile, I'm having great fun shorting financial stocks and buying ultra-short ETFs in my fake investment portfolios (stock games are fun when the actual market isn't).

P.S. The $2-per-share price tag is also significant when you consider that - from what I hear - Bear's headquarters building is worth more than the entire cost of the deal. So essentially Bear paid JPM.

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