The following is a brief overview of the events leading up to the collapse of Bear Stearns on the weekend of March 15, 2008:

Last week, the financial trading firm, Bear Stearns came to a near collapse and was subsequently purchased over the weekend by JP Morgan. The speed at which Bear reached this point was a shock to many, but the purchase was executed in nearly as quick of a timeframe. This purchase was done hastily to prevent any disruption in the mechanics of the financial system both in the US and abroad.

The consequences are more intricate. Bear Stearns was in a fragile position because of the manner in which they operated their business. Most of their revenue was derived from short-term transactions, with a lot of borrowing in short-term instruments. As rumors spread last week that Bear might have issues meeting their short-term obligations, many of their business partners withdrew their assets. We may never know if in fact Bear was in trouble, or it was simply a misguided perception, but given their unique position the rumor was enough to stall their business.

JP Morgan’s purchase of Bear was engineered to avoid any further disruptions in the markets. Unfortunately for Bear, because of the speed of the transaction and the lack of competition, JP Morgan paid a song for Bear Stearns. The total purchase price of $240 million translates to roughly the first 10 floors of their swanky NYC headquarters. Basically, JP Morgan got the deal of a century.

The fallout from this weekend is going to impact the market in several ways. As I write this, we saw the market dip quickly with a minor rally. While we don’t know which direction the market will take this week, the events around Bear Stearns has many investors rattled. In response, the Fed has been an active participant in the acquisition, assisting JP Morgan in managing some of the risk inherent in Bear’s assets and increasing funding into the credit markets.

Tomorrow is another important event, with the Fed meeting to discuss borrowing rates and the overall economy. As of this writing, there is a 90% chance that the Fed will lower the discount rate by another 1.0% to a rate of 2.0%. This would be the fifth time the Fed has lowered rates in the past few months, creating a tremendous stimulus to the economy.

We have now had several months of bad news from every corner of the world. First, the major banks announced nearly $150 billion in losses related to sub-prime loans. In January, Societe Generale, the French bank, dumped all the positions from their “rogue trader” causing the European markets to drop 9% at one point. We’ve had a couple of major hedge funds fail, unemployment is rising and the economy is slowing. These are the fact-based events which have led to the volatility in today’s markets.

But now we’ve had two major events that are based in perception rather than fact. Three weeks ago the municipal bond market froze up, behavingas if muni bonds are risky assets (their historical default rate is a miniscule 0.03%). And this weekend a trading firm has sold at a fire sale price because of a rumor-induced “run on the bank.” We have left the world of fact and are now reacting to irrationalities, a sign that we are reaching the crescendo associated with the bottom of such a market.

While this does not mean we are bullish on the markets, we are closely watching the situation for opportunities. Our current equity holdings are scrutinized and selected based on their long-term value prospects. For many of our clients (as appropriately deemed by our individual risk profiles) we continue to strive for a high dividend yield to buffer the inherent volatility in equity investment vehicles. While our equities may fluctuate in the short-term with these market conditions, we have vetted them extensively for their growth and income prospects as the economy improves and the market stabilizes. We will continue to navigate the global markets with this perspective, while using stable assets such as bonds and cash to mitigate the short-term volatility and provide long-term income.

As usual, please call or email me with questions and comments.

Regards,

David