Note the red horizontal line above is at the $2 mark. 
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Since the announcement of the $2 dissolution of Bear Stearns, the stock has undergone a puzzling rally.  After gapping down 94% or so Monday morning, the stock of BSC traded up to $7+.

Floyd Norris posed the "Great market puzzle" of the day:  Why was Bear Stearns stock trading so much above what Morgan plans to pay?

Today's WSJ notes that Bear's stock has soared 23%. Their answer: "bets that J.P. Morgan will have to pay more for the firm, setting the stage for a high-stakes game of brinksmanship with investors in one corner and the Fed and J.P. Morgan in the other."

I think that's wrong.

There is a simpler explanation, one that might surprise you: BOND HOLDERS are buying up Bears loose stock. As much as they can get. 

Why?

THEY WANT TO MAKE SURE THE DEAL GETS DONE!

 

Consider: there is ~$75 billion in outstanding bonds (see Bloomberg screen below), and another $75 billion in other miscellaneous paper. (UPDATE: The NYT pegs it at $300B).  Prior to the BSC/JPM deal's announcement, the BSC Bonds were trading for 80 cents on the dollar.

Imagine your fund owned a one billion dollars worth of Bear bonds (mark to market = $800 million).  Isn't it worth buying 10  million shares or so at $3 - 4 or so dollars a share? You will get $2 per share in JPM stock, so buying it a few bucks over the takeover price isn't all that risky. Remember, insiders own 30%, and Joe Lewis also owns about 10%.

So as mad as the accumulation appears, its actually quite rational -- IF YOU ARE A MAJOR BOND HOLDER, and are doing this to capture voting stock. (All the other idiots buying BSC are pretty much fucked).

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Bear Stearn Bond Issuances

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Also on the case: Felix Salmon, David Neubert   

As I have been saying, this was an orderly liquidation -- not a bail out. The Fed would have been embarrassed to have Bear Stearns go belly up on their watch -- even though the official coroner's pronouncement was a deadly cocktail of a love of mortgage backed securities mixed with weak risk management. The thinly traded mortgage-based paper got marked lower and lower because NO ONE ELSE WANTED THEM. That is what caused the run on the bank, and not any whisper campaign.

Quite bluntly, its tough to see who else can come in at any sort of premium. The structure of the JPM deal is unique -- they have the Fed's $30B backstop (no one else has that guarantee); They also are guaranteed Bear's HQ -- its essentially a break up fee if the deal does not go through (making Bear worth $1.1B less to anyone else).

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UPDATE: March 19, 2008 9:48am

I just noticed the NYT has a piece on this same issue: It’s Bondholders vs. Shareholders in a Race to Buy Bear Stearns Stock -- They also state the total outstanding Bear bonds are $300B ...

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Sources:

Quick Opening Reactions
Floyd Norris
NYT, March 17, 2008,  10:14 am   
http://norris.blogs.nytimes.com/2008/03/17/quick-opening-reactions/

Bear's Run-Up Sets the Stage For Epic Clash
Speculators Ignite Rally, Driving Shares Up 23%;
Disbelief on Deal Price
MATTHEW KARNITSCHNIG and DAVID ENRICH
WSJ, March 19, 2008; Page C1
http://online.wsj.com/article/SB120588302940646809.html

It’s Bondholders vs. Shareholders in a Race to Buy Bear Stearns Stock
LANDON THOMAS Jr.
NYT, March 19, 2008; Page C1
http://www.nytimes.com/2008/03/19/business/19bear.html