Bargaining in the shadow of bankruptcy

If the alternatives to agreement determine the terms of an agreement, the recent run up in Bear Stearns' price must mean that investors must think that bankruptcy is a good alternative to the $2/share that JP Morgan is offering:

Betting that J.P. Morgan Chase & Co. will have to pay up to seal its fire-sale deal to acquire Bear Stearns Cos., speculators drove up the stock 23% yesterday to $5.91 in heavy volume on the Big Board.

The run-up in Bear Stearns shares has set the stage for a high-stakes game of brinksmanship, with angry investors in one corner and J.P. Morgan Chief Executive James Dimon and the Federal Reserve, which pushed for the deal, in the other.

UPDATE: New Deal

JPMorgan Chase raised its offer for Bear Stearns, the beleaguered investment bank, to $10 a share Monday morning in an effort to pacify angry Bear shareholders.

While the initial agreement appeared to have defused the financial crisis of confidence that undid Bear, the initial terms of the deal — and the government’s controversial role in reaching them — drew criticism from those who say the takeover amounts to a government bailout of Bear, a firm at the center of the mortgage meltdown.

As part of the original deal, the Fed guaranteed to take on $30 billion of Bear’s most toxic assets. Under the revised deal, JPMorgan Chase will bear the first $1 billion of any losses associated with the Bear Stearns assets being financed and the Fed will finance the remaining $29 billion on a non-recourse basis to JPMorgan Chase.