BEAR STEARNS SAVED FROM DROWNING BY BERNANKE
Exciting times on Wall Street as the big boys hang onto the windowsills high above the street by their fingertips, hoping someone will arrive with the net, below.
Bear Stearns, one of the biggest (#5) and most arrogant players among the Masters of the Universe, as Tom Wolfe put it in Bonfire of the Vanities, his colorful, perceptive story about justice and rich kids, took the pipe yesterday, falling 47% in one day. No tears here and I don't have anything to do with them.
So the Fed arrived with the safety-net. It pulled some strings and agreed to stand for Bear Stearns's debt, in order not to scare the world by another Trade Center collapse in the heart of the engine that makes the U.S. roar in the financial centers of the world. This happens to be located everywhere that a bank lends a buck to a business person or a guy trying to put a roof over the heads of his wife and kids, from microloans in Bangladesh to megabucks in London, Paris, Tokyo, Hong Kong and places east and west, north and south.
Does this mean that we now own Bear Stearns? Or are they free to continue to mismanage their risk and expect us to bail them out yet again?
I wonder how much in the way of bonuses their people took home over the last few Christmases. Will they give any of the money back?
Will they receive bonuses this year for not drowning, since we saved them?
Fed Invokes Little-Used Authority to Aid Bear Stearns (Update4)
By Scott Lanman
March 14 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke invoked a law last used four decades ago to keep Bear Stearns Cos. from collapsing after the securities firm sought emergency funding from the central bank.
The loan to Bear Stearns required a vote today by the Fed's Board of Governors because the company isn't a bank, Fed staff officials said. The central bank is taking on the credit risk from Bear Stearns collateral, lending the funds through JPMorgan Chase & Co. because it's operationally simpler to accomplish than a direct loan, the staff said on condition of anonymity.
Bernanke took advantage of little-used parts of Fed law, added in the 1930s and last utilized in the 1960s, that allow it to lend to corporations and private partnerships with a special board vote. The Fed chief probably sought to stave off a deeper blow to the financial system from a Bear Stearns collapse, former Fed researcher Keith Hembre said.
``The Fed really doesn't have any obligation to help a non- bank aside from its role or responsibility to keep the financial markets functioning,'' said Hembre, who helps oversee $107 billion as chief economist at FAF Advisors Inc. in Minneapolis. ``They made a judgment, probably an accurate one, that they're not going to function very well if you've got a full-blown crisis with a major Wall Street firm.''
Unanimous Vote
The Fed said in a statement that it will ``continue to provide liquidity as necessary to promote the orderly functioning of the financial system,'' repeating reassurances the central bank has made often since credit strains arrived in August. The statement said the Fed Board unanimously approved the arrangement with JPMorgan and Bear Stearns.
The Fed Board, which met today at 9:15 a.m. Washington time, typically delegates such discount-window lending authority to its regional reserve banks when it comes to loans to banks.
``There's a clear realization among people both in the official sector and the financial markets that some of the institutions we have built over the last 100 years are not well adapted to the modern 21st century financial system,'' said former New York Fed research director Stephen Cecchetti. ``A lot of what we've been seeing have been creative innovations to deal with problems that the institutions were not built to handle.''
The senior staffers declined to describe how large the loan to Bear Stearns is, and whether a private-sector bailout was attempted first before the Fed extended credit through JPMorgan. The staff officials said the Fed used its authorization under the law several times in the 1960s though didn't immediately have further details.
Paulson's Support
Such votes require approval from five Fed governors. The seven-member Fed board currently has two vacancies, and one governor, Randall Kroszner, is serving past the Jan. 31 expiration of his term.
Treasury Secretary Henry Paulson, in a separate statement, said ``there are challenges in our financial markets, and we continue to address them.'' Treasury is ``working closely'' with the Fed and the Securities and Exchange Commission.
``I appreciate the leadership of the Federal Reserve in enhancing the stability and orderliness of our markets,'' Paulson said. ``Our financial system is flexible and resilient and I am confident that the efforts of regulators and market participants will minimize disruption to the system.''
Robert Rubin, the former Treasury secretary who is now chairman of Citigroup Inc.'s executive committee, said at a conference today that the ``risks have reached a point that the right thing is to act and act in a very serious way.''
47% Plunge
Bear Stearns shares plummeted a record 47 percent on news of the bailout. The announcement, coupled with a report showing U.S. consumer prices were unchanged in February, led traders to place 56 percent odds that Fed policy makers will lower their benchmark interest rate by a full percentage point at their March 18 meeting, to 2 percent.
Yesterday, the odds of such a move were 0 percent.
A reduction of that size would be unprecedented since the overnight lending rate became the Fed's main policy tool around 1990, trumping the Jan. 22 emergency cut of 0.75 percentage point.
It's the first time since the financial turmoil intensified in August that Bernanke, 54, has publicly announced Fed assistance to a specific company instead of measures open to broader sets of banks or other financial institutions.
Most recently, the Fed on March 11 announced plans to lend $200 billion in Treasuries to primary dealers in exchange for debt that includes mortgage-backed securities. Last week, the Fed increased funds available through its so-called Term Auction Facility, set up in December to lend funds to banks in exchange for a wide variety of collateral, including mortgage debt.
`All the Problems'
``What they're doing now is going to help, but I don't know that it will solve all the problems out there,'' said Thomas Garcia, managing director of Thornburg Investment Management in Santa Fe, New Mexico, which oversees $50 billion.
Bear Stearns's liquidity problem ``definitely gives some doubt as to whether other firms are releasing all available information, and whether this credit crunch is really over,'' Garcia said.
Bear Stearns isn't alone among financial institutions stung by the credit squeeze to be bailed out. The U.K. government was forced to nationalize Northern Rock Plc last month after the first run on a British bank in more than a century and take on 100 billion pounds ($203 billion) in liabilities. Two German banks have also received emergency aid.
While U.S. authorities have been faster than their U.K. counterparts in announcing the rescue package for Bear Stearns, former Bank of England policy maker Willem Buiter says that doesn't make their course of action was the correct one.
``This creates the same moral hazard issues that we saw with Northern Rock,'' said Buiter, now a professor at the London School of Economics. ``This bank is being given access to public money, and we don't know what the terms are.''
To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.
Last Updated: March 14, 2008 17:34 EDT
Here's Forbes Magazine's take:
Market Scan
A Shaggy Bear Story
03.14.08,
4:10 PM ET
Friday's Federal Reserve-backed bail-out of Bear Stearns seems to be the beginning of the firm's swan song. A rescue plan hatched by the New York Federal Reserve Bank and JPMorgan Chase is likely aimed at preventing an international financial crisis rather than maintaining the wounded Bear as a going concern.
Just days after
Bear Stearns
Chief Executive
Alan Schwartz
said there was "absolutely no truth" to the speculation that the brokerage firm had liquidity problems, rating agencies cut the firm's debt gradings, including its short-term obligations. That will make it hard for Bear to borrow in the money markets.
Bear got a 28-day respite earlier on Friday, although at a potentially high cost.
JPMorgan Chase
announced that it and the Federal Reserve Bank of New York will provide Bear Stearns with temporary funding. JPMorgan, which is technically a commercial bank, will funnel discount-window borrowings from the Fed to Bear Stearns, Morgan said. Morgan did not say how it will be compensated for its assistance, but it did reveal that it would not take on any significant risk from Bear Stearns' financial problems.
JPMorgan also said it was "working closely with Bear Stearns on securing permanent financing or other alternatives for the company." "Other alternatives" could end up meaning that Bear will be acquired, with JPMorgan an obvious candidate to take over its rival.
Shares of Bear Stearns plummeted on the news, down 47.4%, or $27.00, to $30.00 on Friday. That knocked $3.2 billion off the firm's market value, leaving it at $3.5 billion.
Based in New York, Bear Stearns said its liquidity has crumbled significantly over the past day and that temporary funding will help it operate normally. The firm warned, though, that there is no guarantee that any strategic alternatives will be successful.
"Bear Stearns has $400 billion in assets, $176 billion in securities, and $42 billion in loans outstanding to other clients," noted Richard Bove, an analyst with Punk Ziegel. "Essentially if Bear Stearns went under it would have to liquidize those assets, sell securities, and call in those loans and by doing so generate more security sales that would be dumped into the market sending down prices, and that's what creates a crash."
The Federal Reserve Board in Washington said it would "provide liquidity as necessary to promote the orderly functioning of the financial system." The board also said it voted unanimously to approve the arrangement announced by JPMorgan and Bear Stearns on Friday morning. For the central bank, the hope will be that the situation can be restricted to Bear Stearns. If Bear were to default on any of its obligations, the fear is that it could cause a cascade of failures throughout the world. "That's why the Fed stepped in to support Bear Stearns and will continue to do so until the company shrinks to a level that is defensible," Bove said.
"It's not like Chrysler or Lockheed needing a bailout because of problems within their specific industry," Bove said. "Because the financial system is interrelated worldwide, you can't have a company like this under." Bove went on to add that the Fed isn't large enough on its own to handle Bear Stearns' crisis, and that a concerted effort by central bankers around the world is necessary to ensure confidence in the financial markets.
Bear Stearns shares had already fallen 18.6% between Monday morning and Thursday's close, as reports that the firm might be short of cash dragged the stock it to its cheapest price since the terrorist attacks of Sept. 11, 2000.
Reports surfaced Thursday that some Bear Stearns clients are increasingly reluctant to trade with the firm, and that hedge funds are moving assets away from the firm's prime brokerage.
"The situation is very much that Bear Stearns was very close to the edge and it was much worse than we all thought," Michael Klawitter, currency strategist at Dresdner Kleinwort, Frankfurt, told Reuters. Due to the size and influence of Bear Stearns, Klawitter added that it also raises severe concerns over other firms. "It was the second-largest underwriter of mortgages last year. For the situation to deteriorate in that way is not good news and it will add further to jitters," he said.
Shares of other Wall Street brokerage firms fell on the news, with
Lehman Brothers
sinking 12.3%,
Goldman Sachs
dropping 3.0%,
Merrill Lynch
tumbling 3.9%, and
Morgan Stanley
falling 2.4%.
Many firms are reeling from a credit crisis that began with reckless lending the U.S. mortgage market,
and Bear has been particularly hard-hit. Trouble began brewing last
spring in two of its hedge funds, which ultimately blew up and spiraled
into the subprime mortgage crisis. It has written down more than $2
billion in exposure to mortgage securities. In January, Bear Stearns
announced the resignation of its Chief Executive
James Cayne
after the firm lost billions in the mortgage meltdown. (See: "Cayne Quits As Bear Stearns CEO")
But on Tuesday Bove said that Bear Stearns has more problems than its mortgage business. He said investment banking might be the next domino to fall. "Unless Bear can provide the full services in this sector that its peers are able to provide, it is less likely to pull down the big deals. It will operate with smaller clients in this business," he said. "Bear must also divest employees. It cannot afford what it has. Fewer people means fewer opportunities." (See: "Bear Stearns Beset")
Lehman Brothers attracted attention when it dropped further than its non-Bear peers and announced that it closed a $2 billion bank facility.
Bove said Lehman's drop was connected to the Bear Stearns news, as both have similar business models. Yet those who sell Lehman shares are making a mistake by deserting one of the best-managed companies in the industry, Bove said.
The Associated Press contributed to this article.
***
Here's CNN's take:
In deploying its most powerful weapon on Friday, the Federal Reserve made clear that some banks are simply too big to fail.
While Bear Stearns (NYSE:BSC) ' near-death experience is sending shudders through the financial world, it also provided a reminder that banking giants have the ultimate insurance policy -- a government rescue.
Previous bailouts, notably the 1998 effort to smoothly wind down hedge fund Long-Term Capital Management, have generated cries that the government, by creating moral hazard, is sowing the seeds of the next financial collapse.
Such criticism may be more muted now because market turmoil has already exacted a high toll -- with hedge funds collapsing and all of Wall Street recoiling.
Last August, when the Fed came to the rescue by lowering the discount rate after the failure of two Bear Stearns hedge funds, former Labor Secretary Robert Reich bemoaned the moral hazard in the Wall Street safety net.
The Fed's promise to "promote the orderly financing of markets," Reich wrote, "means that lenders, credit-rating agencies, financial intermediaries and hedge funds will be bailed out."
But after the Fed's rescue of Bear Stearns Friday, Reich compared it with "someone with an helium tank blowing more air into a leaky balloon."
"It only postpones the inevitable, which is that the balloon will lose its air and float back to Earth," Reich wrote.
In other words, he's not too concerned about financiers getting carried away with risk.
Stop The Run
"This whole situation has been rife with moral hazard, but that doesn't mean people haven't learned lessons," said Don Luskin, chief investment officer at Trend Macrolytics.
Luskin, though, doesn't see a moral hazard in the New York Fed's move to provide emergency financing to Bear Stearns.
The Fed was created precisely for that purpose -- "to step in and prevent a run on a bank."
Rather, the moral hazard came from the Fed lowering its key borrowing rate to 1% in 2003 and keeping it there for too long.
By making money available at a negative real interest rate, it encouraged mortgage providers to "lend money to people who don't have jobs," Luskin said.
Long Morality Play
Others, such as Morgan Stanley (NYSE:MS) economist Stephen Roach, have been arguing for years that the Fed was a serial bubble blower.
"The Federal Reserve is trapped in a moral-hazard dilemma of its own making," he wrote in 2005. "It dates back to the Great Bubble of the late 1990s and the central bank's unwillingness to take away the proverbial punch bowl just when the party was getting good."
What followed was a post-bubble deflation scare that led the Fed to slash rates and inflate the mortgage debt bubble, he wrote.
Luskin has a different take. He sees the Fed as a clumsy tightrope walker that overcompensated by holding rates too high in the late '90s and then holding them too low early this decade after the Nasdaq crashed.
Back in 2003, Doug Noland, author of the Credit Bubble Bulletin, described the central bank as being "held hostage to the markets -- financial and real estate."
The Fed was no longer able to provide an anchor as it did when bank lending dominated the credit system, he said. Yet it was required to ensure liquidity to accommodate the explosion of derivatives markets, Noland said.
The expectation of central bank bailouts has "lowered perceptions of risk in the market," wrote Paul de Grauwe, economics professor at Belgium's University of Leuven, in the Financial Times last August.
He said the way to solve the problem is to make banks that want preferred rates from the Fed to accept regulation of their hedge funds.
"Securitized debt instruments are very powerful, but very dangerous, tools," Luskin said. "Securitization is a good idea. . . . We just have to learn a little more about transparency and risk management."
Newstex ID: IBD-0001-23786262
Originally published in the March 17, 2008 version of Investor's Business Daily.
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Cecchetti wrote a kindergarten book on banking, with contrived
simplifications whose distinctions are arbitrary. Then he wrongly
says the Fed prints money. He says Euromoney was created to protect
soviet interests. He says underwriters guaranty IPO prices. He says
Glass Steagall restricted the "economies of scope" which he says
caused the Great Depression. He bypasses modern problems with
transaction costs with is simplistically sweeping statements.
Institutions who use this textbook should not expect their graduates
to obtain serious jobs. In fact, accreditors should examine student
exam papers at such institutions to see if they really learned
anything. Any institution using this book should be liable for
malpractice as your kid will fail any chartering exam studied for with
this book. As for Cecchetti himself, he should be run out of town,
made to return to his dead soviet masters. We should not be in the
business of propogating more useless ditzy educators who deliberately
resist productive contributions but instead sabotage society through
misinformation. This book is a great example of why students should
be expected to take standardised examinations on their majors before
(or instead of) obtaining degrees. This textbook is proof of the
abject bankruptcy of American academia whose affected self-propogation
and self-preservation sabotages our society.
Posted by: Mario Brinocci | March 24, 2008 at 01:27 PM