The weirdness on Wall Street continues. The world’s greatest fire sale has turned into something of a fiasco for JP Morgan, who thought they had Bear Stearns wrapped up in a bow by the Fed at $2 per share. However, the deal has started unraveling thanks to angry BSC shareholders, and JPM now has quintupled its offer to $10 per share:

The sweetened offer is intended to win over stockholders who vowed to fight the original fire-sale deal, struck only a week ago at the behest of the Federal Reserve and Treasury Department.

Under the terms being discussed, JPMorgan would pay $10 a share in stock for Bear, up from its initial offer of $2 a share — a figure that represented a mere one-fifteenth of Bear’s going market price.

The Fed, which must approve any new deal, was balking at the new offer price on Sunday night after several days of frantic, secret negotiations, these people said. As a result, it was still possible the renegotiated deal might be postponed or collapse entirely, said these people, who were granted anonymity because of their confidentiality agreements.

If the Fed were to reject the new proposal, it could set off a furor among shareholders of both firms that the government was preventing them from making a fair deal.

The Fed may have caused some of the problem itself. Its new $200 billion lending facility could have been used by Bear Stearns to reverse some of the bad paper it has acquired. That has shareholders who bought BSC when it rode high wondering why they need to sell their assets at 6 cents on the dollar now.

They especially object to the Fed’s pushing of the $2 share price after working with JPM to guarantee $30 billion of BSC’s worst-performing assets. BSC shareholders ask why the Fed simply didn’t offer that guarantee to BSC instead, and why they forced such a low price for the deal. The answer — that the Fed didn’t want to be seen bailing out Bear Stearns and especially the management that created its crisis — hasn’t satisfied the people holding nearly-worthless BSC shares. They feel as though they have to sacrifice for the Fed’s need to save face.

The irony, of course, is that without this deal, the shareholders would have had no value at all. Bear Stearns would have sunk under the red ink of its bad paper, and instead of 6 cents on the dollar, the only value the shares would have had would be as kindling for a warm fire in a winter cabin. But the structure of the bailout left the obvious question of why the Fed had acted in such a Deus ex machina manner, picking winners and losers with what looks like a hefty dollop of capriciousness. Why not just provide the same guarantees to BSC contingent on the removal of the board and chief executives, for instance?

This is the problem with muscular government intervention in markets. Even though BSC deserved bankruptcy for its terrible management in the marketplace, the fact that the government (or its auxiliary in the Fed) determined the winners and losers makes it political rather than the natural result of gross incompetence. The problem with the increased share price is that it makes the Fed action more clearly a bailout of BSC shareholders, and the Fed’s own guarantees make a higher share price inevitable. (via Tom Maguire, who has more thoughts)