Bear deal goes under the microscope

NEW YORK (CNNMoney.com) -- The Senate took a long, hard look at JPMorgan Chase's planned purchase of Bear Stearns on Thursday, grilling both executives and federal regulators who helped shepherd the controversial deal.

Members of the Senate Banking Committee, digging into the terms of the extraordinary tie-up at a five-hour hearing, pulled back the curtain on a merger that many critics have argued amounts to a bailout of Wall Street.

Federal Reserve Chairman Ben Bernanke, making his second straight appearance before lawmakers this week, was among those who defended the 11th-hour deal. Bernanke argued that preventing the collapse of Bear Stearns, the nation's fifth largest investment bank, staved off a run on other investment banks, damage to the broader American financial system and the U.S. economy.

"The truth is that the benefactors of our actions were not Bear Stearns or principally Wall Street - it is Main Street," said the central bank chief.

Those remarks were echoed by other witnesses, including Timothy Geithner, president of the Federal Reserve Bank of New York, one of the chief architects of the deal, and JPMorgan Chase (JPM, Fortune 500) Chairman and CEO Jamie Dimon and Bear Stearns (BSC, Fortune 500) CEO Alan Schwartz.

"One thing I can say with confidence: if the private and public parties before you today had not acted in a remarkable collaboration to prevent the fall of Bear Stearns, we would all be facing a far more dire set of challenges," JPMorgan's Dimon said.

Thursday's hearing marked the first time the two Wall Street execs have spoken publicly on the merger since the deal was announced on March 16.

At the time, JPMorgan agreed to buy Bear Stearns for $236 million, or only $2 a share. A little over a week later, JPMorgan raised its bid for the investment bank to $10 a share amid anger from both shareholders and employees over the deal.

To pull off the purchase, however, the Federal Reserve Bank of New York agreed to take control of $30 billion of Bear Stearns' assets. As a result, JPMorgan will now bear the risk of the first $1 billion in losses were Bear Stearns assets to go bad. The New York Fed would cover the remaining $29 billion.

The Fed's unusual maneuver drew the scrutiny of lawmakers, who questioned the central bank's decision to put public funds at risk by essentially agreeing to back Bear Stearns' portfolio, which included those same mortgage-backed securities that have plummeted in value since the housing market took a nosedive.

"We've heard other financial institutions say that they, in fact, can't truly verify the full value of their securities," said Sen. Robert Menendez, D-N.J. "So, if we don't have a valuation of these securities, how are we so confident?"

$2 a share and the discount window

Thursday's hearing provided a glimpse into how the deal came about after Bear Stearns revealed to the SEC, the Fed and JPMorgan that it was facing severe liquidity issues.

At the time, Bear Stearns' Schwartz was facing an exodus of both customers and business partners following rampant speculation that its underlying health was in jeopardy.

Schwartz suggested to lawmakers that the speculation could have been an organized effort to manipulate the market.

"I would just say as an observer of the market, it looked like more than fears - there were people that wanted to induce a panic," Schwartz said.

Despite securing a short-term loan from JPMorgan on Friday, March 14, the company's liquidity position continued to weaken. By the end of the day, Schwartz said the company faced two choices: finding a buyer or face the possibility of filing for bankruptcy the following Monday.

Even though Bear Stearns attempted to court other partners, only JPMorgan was willing to commit, according to Schwartz.

One question that occupied lawmakers' attention was how the initial $2 asking price for Bear Stearns was reached and if regulators were involved in determining that price.

"We did not set or negotiate the price," said New York Fed President Geithner.

Geithner said the agreement was guided by twin principles: averting default by Bear Stearns but at the same time not sending the message that the government would bail out other firms when their business goes bad.

JPMorgan's Dimon added that the price also took into account the risk that it was taking by purchasing Bear Stearns on such short notice.

"We literally had 48 hours to do what normally takes a month," said Dimon.

Still, lawmakers wondered whether Bear Stearns could have been saved. After JPMorgan announced plans to acquire Bear Stearns, the Federal Reserve took the drastic move of opening its discount window to investment banks and brokerages to calm jittery markets about liquidity.

Some experts have suggested that the Fed could have opened the discount window when fears first emerged about the health of Bear Stearns.

"It was not at all obvious to me it would have been sufficient to prevent their bankruptcy," said Fed chief Bernanke.

Bear Stearns' Schwartz disagreed.

"It is highly, highly unlikely we'd be in situation we found ourselves in today," he said.

Congress wants answers

The unorthodox rescue of Bear Stearns by the Fed has been a hot topic on Capitol Hill.

On Wednesday, members of the Joint Economic Committee of Congress grilled Federal Reserve Chairman Ben Bernanke about the Fed's role in engineering a deal between the two firms.

At the same time, the top two lawmakers on the Senate Finance Committee - Sens. Charles Grassley, R-Iowa, and Max Baucus, D-Mont. - have also been pushing for further details on the controversial deal.

On Wednesday, the pair sent a letter to Schwartz and Dimon requesting details about any compensation or severance arrangements as part of the merger. In addition, the two lawmakers asked the Securities and Exchange Commission Thursday why the regulator sought no enforcement action against Bear Stearns for improperly valuing its mortgage-related investments.

There has been plenty of talk this week that the U.S. financial system requires a drastic overhaul to prevent such a crisis from happening again.

Treasury Secretary Henry Paulson outlined a blueprint for changes on Monday that would combine a handful of federal regulators and provide greater power to the Federal Reserve.

While Thursday's hearing provided few answers about what actions should be taken, both witnesses and lawmakers urged change.

"If we continue to react to situation after they happen, where are we going to be?" asked Sen. Richard Shelby, R-Ala., the ranking GOP member of the committee.