If weekend suitors do not rescue Bear Stearns, we are likely witnessing a turn out the lights party for the Bear. CNBC is reporting Bear Stearns Weekend Talks Reveal 2 Key Contenders.

Department heads at Bear Stearns met with officials at J.C. Flowers and JPMorgan Chase Saturday afternoon to give an overview of their business divisions, including headcount and profit and loss positions, CNBC has learned.

The discussions indicate that potential bidders for Bear have been narrowed to those two CNBC.com firms, although other last minute contenders could still weigh in, according to one source aware of the talks.

S&P; Downgrades Bear Stearns Credit to BBB

In a “timely” move, the always on top of things S&P;, lowered its long-term counterparty credit rating on Bear to “BBB” from “A,” and it placed long and short term ratings on credit watch with negative implications.

Because of that S&P; downgrade, bankers have now come to the conclusion that a deal must be done by Monday morning because no one on the street will trade or lend to Bear Stearns, which is rated a notch above junk bond levels.

China Backs Out Of Existing Bear Stearns Deal

Don’t look for Chinese sovereign wealth funds for a bailout: China’s Citic won’t guarantee completing Bear Stearns investment.

China’s Citic Securities Ltd. said Saturday that it can’t guarantee it would complete a deal to invest about $1 billion in Bear Stearns Cos. due to the U.S. investment bank’s financial crisis, Reuters reported Saturday.

“Our company has noticed the recent financing arrangement with the U.S. Federal Reserve and JPMorgan Chase and other financial institutions, and we have also considered factors including the sharp fall in Bear Stearns’ share price.

We cannot guarantee reaching a final agreement in the future,” Citic Securities was quoted as saying.

Massive Derivatives Mess At Bear Stearns

With a tip of the hat to Prudent Bear let’s take a look at the Bear Stearns’ 2007 SEC 10k filing page 80.

As of November 30, 2007 and 2006, the Company had notional/contract amounts of approximately $13.40 trillion and $8.74 trillion, respectively, of derivative financial instruments, of which $1.85 trillion and $1.25 trillion, respectively, were listed futures and option contracts.

The aggregate notional/contract value of derivative contracts is a reflection of the level of activity and does not represent the amounts that are recorded in the Consolidated Statements of Financial Condition. The Company’s derivative financial instruments outstanding, which either are used to offset trading positions, modify the interest rate characteristics of its long- and short-term debt, or are part of its derivative dealer activities, are marked to fair value.

The Company’s derivatives had a notional weighted average maturity of approximately 4.2 years at November 30, 2007 and 4.1 years at November 30, 2006. The maturities of notional/contract amounts outstanding for derivative financial instruments as of November 30, 2007 were as follows:

click on chart for sharper image

I followed leads on the above to Bear Stearns: The Smoking Gun(s) and from the same blog 2007-2009 Bear Market Update. A snip from the former also made reference to the above chart with the following additional commentary.

This market has become a leveraged nightmare, being so large that the failure of any single significant company such as Bear Stearns could precipitate a chain reaction of defaults. As you may recall we pointed out some time ago that after subprime the next area to watch closely as a potential tipping point would be the CDS market.

[click on chart for sharper image]

Notice that Bear Stearns is not EVEN LISTED as holding derivatives in any of the tables we looked at in the OCC Report. Is this because of their ‘non-bank’ status? We wonder how many other US corporations are quietly loaded up with derivatives risks as well, either as a large counterparty, or the target of a pyramid of wagers on failure risk many hundreds of times their actual net worth. What a monster Wall Street has created for the world.

Let’s Not Pretend

I am not going to pretend that I know how much of that is real vs. imaginary risk. But as long as we are not pretending, let’s not pretend about this:

  • Whatever the risk is, it is enormous.
  • That risk is 100% guaranteed to not be marked to market.
  • There is no freaking way, no matter how many people are thrown at the task, to figure out the above mess with any degree of certainty by anytime next week, let alone Monday.

Fannie Mae’s hedge book could not be figured for over two years. Can Bear Stearns’ hedge book be figured out in two days?

Mike “Mish” Shedlock
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