A hedge fund junkie and devoted Going Private reader asks this morning after some rather philosophical nuances of market dynamics. Is pricing information in an auction meaningful if nothing is sold? (I would think so, but perhaps I am a minority here). The context, of course, is the Bear Stearns sub-prime story that I have beaten nearly to death in these pages already. The Wall Street Journal gives us this morning's local color on the subject.
J.P. Morgan Chase & Co., a lender to Bear's hedge funds, was scheduled to begin an afternoon auction of collateral it held from the Bear fund, mainly mortgage-backed debt. Minutes before the sales were to begin, the firm pulled back. Later, J.P. Morgan came to terms with Bear to eliminate its exposure to Bear's troubled hedge funds, said a person briefed on the matter. Some traders said the bank might have been forced to settle with Bear because the loans it had put up for sale would have fetched so little in the market.
Merrill also planned to sell collateral and stopped negotiating with Bear, according to a person familiar with the matter. Due to the mortgage market's restless state, some of the early prices bandied about for Merrill's assets were relatively low.
This brings up some interesting questions: What exactly does a "reserve price" mean in a forced auction of securities made to satisfy margin calls? If, in fact, JP Morgan, was not able to meet its "reserve price" in the auction and therefore held the collateral instead what does this imply for the securities in question? How does one now mark them to market. At the reserve price? At the highest non-accepted bid?
Clearly, there is some pricing information here, but it is obviously not beneficial for any of the parties involved to let that signal leak out if it is so low that it is likely to be damaging- and this seems to be the case. This brings up another fuzzy issue (there seem so many of these in this story). What amount of Bear's outstanding margin debt must Merrill or JP Morgan consider satisfied in such a case? The highest non-accepted bid? Some other amount? Will JP Morgan just decide what amount the collateral is worth now? Based on what formula? Will they just put the collateral in the books at some invented level? How will the amount the collateral is marked to market with relate to the margin satisfaction number? Or will it be related at all? After all, if JP Morgan takes the collateral and then discharges $200 million in Bear margin debt then hasn't a sale for $200 million taken place? Will the collateral go on the books at this price? (Want to take bets?)
Another email and a phone call this morning hint at the rumor that the bids on Merrill's forced collateral sale of Bear assets also resulted in prices so low that the auction was halted. It is difficult not to be skeptical of the sudden re-negotiation with Bear these firms seem to have joined.
The implication here (and this is, of course, rank speculation) is that these firms are terrified of allowing any legitimate pricing information to leak out to the market. Why not? Why not hang onto the stuff and repackage or resecuritize it? Bundle it with some higher rated instruments and pay (read: cajole) a rating agency to AAA it (I love using "AAA" as a verb- "Triple-A it!" Try it with your friends) and pawn the same toxins off to the greater fools of the world.
What is the take-away here? Who is the final authority on the value of these assets, a critical piece of data to price similar toxins in the rest of the market? Is it acceptable to ignore- nay- actively conceal pricing information? Who will force realistic disclosure here? The Board of Directors? The SEC? Bank regulators?