Tuesday, October 23, 2007

Bear Stearns sticks toe in Chinese investment waters: what’s it mean?

U.S. investment bank Bear Stearns has joined forces with China’s Citic Securities in an investment alliance that involves each bank investing $1 billion in the other.

Here’s the details, courtesy of MSN and the New York Times.

Citic will acquire about $1 billion of 40-year convertible trust preferred securities that will convert, on a fully diluted basis, to approximately 6% of Bear Stearns' shares; Bear will seek regulatory approval with China to acquire a similar stake in Citic for about $1 billion through a six-year convertible debt security and five-year options to acquire additional shares.

"This groundbreaking alliance will give Bear Stearns a unique footprint in one of the world's fastest-growing economies through a strategic partnership with a premier market leader," Bear Chief Jimmy Cayne said in a press release this morning. "We are confident that combining our operations in Asia with Citic Securities will greatly benefit Bear Stearns' global client base and generate substantial new revenues and growth opportunities for the firm over the long term."

Rumors had been swirling that Bear Stearns was looking to sell a stake in itself after the demise of two of its subprime-based hedge funds hammered the Wall Street bank this past summer. Bear reported a 61% drop in profit in the third quarter because of the mortgage-market meltdown.

So, in other words, Bear is probably still worried about not having enough liquidity, and that’s half of why it’s been pressing for this deal. If that’s the case, expect clamor for further Fed rate cuts, as well as a backstop “pool” of money from the Fed, Bank of England and the European Central Bank. Also consider the possibility that the likelihood of other, taxpayer-funded, liquidity steps has increased.

In exchange, Bear gets increased access to the theoretically valuable Chinese investment world.

But, just as much of the “tranches” from collateralized debt obligations here were never “marked to market,” that is, never had an open-market price calculated before being sold, it’s my considered non-professional opinion that much of the entire Shanghai stock market, and collateral investment centers, isn’t adequately marked to market.

In other words, China could have a bubble, too, perhaps in part caused by a U.S. backfire, since China has so many eggs in just a few American baskets.

My off-the-top-of-my-head guess is that the Shanghai stock exchange is overvalued by 20 percent. Maybe more.

What if other American investment banks make deals similar to Bear, and then this Chinese bubble bursts?

Definite recession. Perhaps a biggie.

Part of the problem here is the world hasn’t had a serious recession since China became a global economic player. So, I think professional economists far smarter in the “dismal science” than I probably have little more than guesstimates to offer on how well China could weather a 20 percent burp in its stock market.