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The Tip of the Iceberg JP Morgan and Bear Stearns (A) Case Solution
JP Morgan Chase, a leading corporate lender, was formed from many bank mergers. These banks include in the formation of JB Morgan include Manufacturers Hanover, Chemical Bank, Chase Manhattan, J.P. Morgan & Co., Bank One and many other smaller financial institutions. The deal related to buying Bank one, for $58 billion in 2004, encloses a rational decision of having Dimon leading the new firm. The reshaping of the business started immediately as Dimon was appointed as the CEO of JPMC. Bear, Stearns & Co., founded in 1923, was a leading Wall Street’s white-shoe investment bank, placed second in the securities industry behind Lehman. Bear ranked highly for quality management, innovation, and financial stability. Because of stressed financial conditions during the great recession, it is expected that a bear would fail to continue, which can cause high scale disruptions in financial markets. In order to rescue the financial market and Bear from failing, JPMC is looking forward to buying Bear, Stearns & Co.
Following questions are answered in this case study solution
Evaluate the mechanisms used to manage JPMC and how they enhanced or impeded its position as the bank best positioned to buy Bear.
From a commercial perspective, what are the pros and cons of JPMC buying Bear?
What responsibility does Dimon have to the financial―system?
What is the social purpose of an audit, and what categories of opinion might an auditor express?
In the contemporary economic environment, what specific factors inhibit good audits?
Case Analysis for The Tip of the Iceberg JP Morgan and Bear Stearns (A)
1. Evaluate the mechanisms used to manage JPMC and how they enhanced or impeded its position as the bank best positioned to buy Bear.
Out of many changes that were taken to enhance JMPC’s position, one was the formation of the same set of financial reports, which properly explains the revenues, direct cost, shared and allocated expenses of each business. In order to increase the effectiveness and efficiency of the members of the Operating Committee, annual bonuses were given to them on the degree of different quantitative and qualitative factors. Moreover, the head of all the lines of business was not only paid on the performance of their business unit but on the company as a whole.
The financial mechanism used by JPMC for the risk management process was the fortress balance sheet. Using the fortress balance sheet strategy, the financial managers of the firm adopted a conservative approach for the liquidity strategy and for the accounting within the rules. The liquidity and capital levels on JPMC exceeded the requirements required by regulation and maintained by competitors. The liquidity strategy formulated using fortress balance sheet required to have a large amount of cash capital, to have term financing, stress testing, and liquid reserves for illiquid assets. The quality of the capital base was also being taken care of by making it more common equity-oriented rather than preferred stock. Conservative accounting was another major aspect of the fortress balance sheet which does not allow JPMC to recognize the revenues until they are recognized. Although the financial approach resulted in a cost of five percentage points on JPMC’s ROE, it helped the company to tolerate the stressed condition and enhance its position as the bank's best position to buy Bear.
2. From a commercial perspective, what are the pros and cons of JPMC buying Bear?
Buying Bear will be beneficial for JPMC if the financial provided by JPMC will help Bear to continue its business as usual. In 2007, Bear, one of the leading investment banks, had three main operating businesses; capital markets, global clearing services, and wealth management. A successful acquiring of Bear will help JPMC to gain a higher market share in investment securities. JPMC will be able to establish good standing in capital market business, includes brokerage services, market making, and propriety trading. Moreover, JPMC will take advantage of Bear, being the second largest investment bank, by expanding its operations in global clearing services and wealth management.
The negative sides of buying Bear for JPMC are greater than the positive aspects. JPMC considers buying Bear when the financial conditions of the market are under high stress. The rapid deterioration of housing prices has reduced the value of mortgage-backed securities. During this period, credit rating agencies downgraded the credit rating of numerous securities with mortgage-related exposures. The bear was wide-opened to the mortgage market in a number of ways. One way became evident from the collapse of two prominent hedge funds of Bear, managed by its Stearns Asset Management. Bear has invested heavily in illiquid mortgage-backed securities. Because of a large number of mortgage-related securities default, Bear experienced a high level of losses. Under these circumstances, the risk of buying Bear is high which can cause a huge blow to the financial condition and reputation of JPMC if it would not be able to make Bear profitable.
3. What responsibility does Dimon have to the financial―system?
The failure of Bear can be highly disastrous to the smooth running of the financial system. One of the main reasons for this risk is the high interconnectedness of financial institutions.
Derivative transactions and prime brokerage are the main sources of interconnectedness among financial services institutions. Derivative contracts are mostly bilateral contracts that are written between individual firms. These derivative transactions have made investment banks and commercial banks exposed to credit risks – the risk in which counterparty is unable to meet its financial obligations. The bear was engaged in numerous derivative transactions and failure to these transactions would lose the hedging and risk protection created by Bear for its counterparties. The challenge to replace these hedges could cause disruptions in prices and liquidity in the financial.
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