May You Live In Interesting Times

[Winstonm]

Emphasis added.

 

On the Brink of Collapse, Investment Bank Bear Stearns Gets Lifeline From a Rival and the Feds

 

 

NEW YORK (AP) -- On the verge of a collapse that could have shaken the very foundations of the U.S. financial system, investment bank Bear Stearns Cos. was bailed out Friday by a rival and the federal government. The near-miss raised new alarm about the credit crisis -- and whether other big firms might be in jeopardy.

 

The rescue came from JPMorgan Chase & Co. and, in an extraordinary step, the Federal Reserve, both rushing to pump new money into the venerable Wall Street firm after its financial state deteriorated so much in a 24-hour period that it threatened to fail.

 

Bear Stearns stock lost nearly half its market value, about $5.7 billion, in a matter of minutes, and pulled the broader market down with it. The Dow Jones industrial average fell nearly 200 points.

 

If Bear Stearns were to go under, "it has the potential of bringing down the whole market," said Richard Bove, an analyst at Punk, Ziegel & Co. "This is the crescendo of the crisis."

 

JPMorgan and the central bank agreed to extend loans for 28 days to Bear Stearns, the nation's fifth-largest investment bank and the one hit hardest by the subprime mortgage mess.

 

Two hedge funds managed by Bear Stearns failed last summer, setting off a credit crisis that has swept up banks and brokerages around the globe.

 

In backing up JPMorgan, the Fed dusted off a rarely used, Depression-era provision to provide loans. It also said it was ready to step in to fight an erosion of confidence in the nation's largest financial institutions.

 

I have trouble with the Fed's logic on the underlined quote. Bear-Stearns is a broker-dealer, a non-depository institution. That's why JP Morgan had to intervene - as a depository institution, JP Morgan had access to the Fed's "discount window" while Bear-Stearns did not. Bear-Stearns made this choice when they chartered as a non-depository institution. As a non-depository institution, they were free to take more risk. The lost that bet.

 

The Fed was under no legal requirement or mandate to interfere in this collapse.

 

Why bail out an investment bank?

[mike777]

"Why bail out an investment bank?"

 

 

What happens when the fifth largest investment bank fails and should we care?

 

 

The fed said:

1) We do not know

2) We are too scared to find out.

 

Moral if you are going to buy something to big to fail, make sure it is number one or two and make sure you buy below book....hmmm citigroup? :)

 

If possible:

1) buy below book

2) have fed take all the bad loans

3) buy all the good to semigood loans/assets below book....

4) :)

5) repeat process.

[Winstonm]

Mike,

 

I think the Fed is afraid of allowing AAA-rated MBS to be liquidated in a forced sale. By accepting as collateral via JP Morgan and the discount window this AAA MBS, the Fed has avoided market pricing of these products.

 

If the AAA ratings blow up, a super crisis could well be at hand.

[mike777]

"I think the Fed is afraid of allowing AAA-rated MBS to be liquidated in a forced sale. "

 

I thought I just said that :)

 

bias alert

 

Grave dancers really perk up in times like this.

We miss out on all that tech bubble stuff all time. We always miss out on the googles, fill in the blank your fav tech stock.

We feel gloomy while all of you are dancing in the streets. :)

[Winstonm]

Mike, the only "bias" I have (maybe :) ) is to have an artificial prop under an overvalued asset. Bloomberg shows a chart where only 6 of 80 MBS qualify for AAA rating, yet not a single one has been downgraded.

 

I am more fearful of a Japanese-like decades-long bout with deflation than a sudden collapse. At least after a collapse you can rebuild.

 

And hiding bank losses with more bad loans is SO Japanese. Wakari-masu ka?

[kenberg]

One can have a preference. How about a prediction?

 

Will BS be bought up? Will the Fed get its money back? Will the banks become more or less willing to lend money?

 

I guess my thinking is that I hope these guys (The Fed, I guess in consultation with Treasury) know what they are doing. I am nowhere near having even a casual understanding.

 

An attempt at a thought. It seems market forces can be reasonably trusted when the people making the business decision profit from good decisions and lose with bad decisions. In the complex financial markets, individuals can profit greatly my making decisions that are extremely destructive to not only the general public but even for the company that they represent. The corrective force of the market could well drive BS into bankruptcy. The guys who ran it into the ground will, however, walk away extremely wealthy and so are maybe a little upset but not really hurt all that bad. This situation appears to short-circuit the hoped for corrective force of market economics.

 

The lesson market economics teaches here? Destruction for fun and profit.

[Winstonm]

I think the lesson here is that if you are going to steal, steal BIG.

[Winstonm]

Ken,

 

It may help if I explain from my understanding. The MBS I have mentioned is simply Mortgage Backed Securities. These are only packages of home loans sold off as a bond-like instrument. Investment companies worldwide bought these products - the securitization process - taking the loans away from the banks and thus freeing the banks to make more loans.

 

Trouble now is these MBS products have turned poison - few are willing to buy these products so banks have to hold the risk of more of their own loans.

 

This, by its nature, reduces risk-taking and makes loans harder to get.

 

These MBS were further divided into slices - called tranches - and given a credit rating based on something like a triangle/pyramid shape - the higher up the pyramid, the less risk, the lower returns on investment. The top of this pyramid structure is the AAA-rated tranches.

 

Bear-Stearns got itself into trouble by investing in slightly lower tranches, termed Alt-A. Now that those loans have turned bad, the Federal Reserve has deemed it important to save Bear-Stearms from its own incompetence.

 

I would hope that the reasons are sound - a collapse of our financial system - else the Fed is simply throwing Moral Hazard out the window in order to save Wall Street.

 

It also makes me wonder about the real value of the AAA tranches - is the Fed taking AAA MBS as collateral simply to prevent a market pricing and possible rating downgrade of virtually all AAA MBS? If so, then the Fed is engaging in price manipulation that would make the old U.S.S.R. proud.

[mike777]

As you aptly said

keeping bad loans on books for decades is horrible.

I see none of that

 

I thought I predicted:

broad based commodities(sp), buy, as they flood system..yes they may go too/extreme high...sell.....

citigroup under book value..yes it can fall more

1) yes at some point commodites(sp) will be insane..sell..if you bought in 1999 you are dancing.

2) yes even under 22 bucks citicorp can go lower.......

3) I have no idea what the next super tech stock is but yes there is one. I guess MOT is an old foggy tech stock?

4) there are many financial stocks, fin...etfs, fin... mutual funds you need to buy..yes they may go lower next 24 months.

5) bias alert, as an old foggy, I invest in cheap, cheap broad based health care stocks.....I have no idea which one will be genius but I am betting old boomers will spend inflation rate or greater on health care...bias alert.......

[Al_U_Card]

So all the guys that got multi-million $ compensation etc. will get their jobs secured while those that owned the stock etc. get fleeced? Why am I not surprised?

[kenberg]

People tell me I should buy gold!. Maybe, but I am averse to buying things that I have no use for. Anyway, I have no interest in speculating on the current market, or any market for that matter. My interest in this subject is, and I think will remain, in the economic health of the country. If we don't collectively go belly up, I'll be fine. I have no great interest in being rich. I've been on yachts. Boring.

 

So what should we, as a country, do? Does anyone want to make a measurable testable prediction of the short term effects of the Fed action with regard to BS? I freely confess that I have no idea. For example: I gather that the Fed believes/hopes that as a result of the intervention a BS bankruptcy will not take place, probably BS will be bought up, and that the Fed will not have to shell out the money that it has pledged to shore up BS finances. Will this work? Based on very little knowledge but maybe some faith that the Bernanke et all are not idiots, I am guessing that this will work (where "work" means in this limited sense). There could well be a price to be paid down the line, I understand, but a starting point would seem to be "Will the intervention have the planned short term effect?". Place your bets.

 

Long term seems to be much, much, tougher. As near as I can see there is simply no constituency for supporting any political action that involves long term goals over immediate satisfaction. That is a very dismal state of affairs. We have met the enemy and he is us.

[Winstonm]

Long term seems to be much, much, tougher. As near as I can see there is simply no constituency for supporting any political action that involves long term goals over immediate satisfaction. That is a very dismal state of affairs. We have met the enemy and he is us.

 

"Instant gratification's gonna get you

It's gonna knock you right in the head

Better get yourself together, darling

Pretty soon you're gonna be dead"

 

Can we all finally agree that there is no such thing as "spending our way to prosperity"?

[sceptic]

would it not be fair if the FED bails them out, but the people that caused the mess lost everything and gave back all their money to the poor old investors

[kenberg]

Hey you theorists. You are all ducking (well, maybe just ignoring) my challenge to predict whether the Fed action will or will not succeed with its short term objectives. I say yes. But I am not betting the house.

 

Success is defined as: Either BS (the firm, not the manure) becomes viable (unlikely, I understand) or it is bought up in a manner that its financial obligations will be met including the Fed getting its money back.

 

We all agree that mortgage bundlers get the Toad of the Month award, but we still we have this problem to solve.

[Winstonm]

Bear-Stearns will BK, regardless of interventions. I've read that a deal has to be finalized by Monday. There simply isn't enough time for buyers to evaluate the potential losses in the derivative exposure of the Bear hedge book, IMO.

[hrothgar]

I'm probably in a small minority here, however, I don't have any problem with so-called Collateralized Debt Obligations.

 

Don't get me wrong: The CDOs were part of a deeply dysfunctional system... However, I don't blame the instruments themselves. Find new and better ways to slice and dice risk is a valuable economic activity.

 

The problem crops up when people who have no business being in the market start buying and selling these types of instruments. Coupled with this, the bond ratings companies clearly had no idea what they were doing. Last, but not least, some of the big boys in investment banking learned an exciting lesson why its better to own a casino rather than bet in a casino.

 

Personally, I'm against any kind of serious bail out. If Bear Stearns is to crash and burn, so be. If Bear Stearns is really too big to fail then J.P. Morgan or the Saudis should bail it out with their own dime.

 

I understand that this is likely to create some real ugly days on Wall Street. I'll probably be much more exposed than most.

 

I see the alternative (rewarding this sort of idiocy) far worse

[Winstonm]

I'm probably in a small minority here, however, I don't have any problem with so-called Collateralized Debt Obligations.

 

I'm not against the concepts of these products, either. The failure seems to me to have been in restraint and oversight - and the ratings system.

 

It appears that the entire financail complex has become so opaque that it is impossible to determine the consequences of a failure - therefore, the safest strategy, the Fed seems to have adpoted, is to prevent having to find out what would happen.

[kenberg]

I'm more than willing to believe that the fundamental concept of CDOs has some merit. Thanks to the Forum I have some (limited) understanding of them.

 

I'm a mathematician. If I present a mathematical analysis, if people trust it, and it crashes, they don't want to discuss whether the calculation tools that I used are generally sound, they want to discuss the fact that the way I used them led to disaster. So it is here. These bankers and financiers are the experts. If they say CDOs are a good idea, who am I to tell them that they are wrong. But then they have to be right. Not only right that CDOs are a good concept but they have to implement them effectively.

 

They failed. Maybe through greed, maybe through stupidity, maybe (my guess) through both. But they failed, and they won't easily restore the trust that they previously enjoyed. It is this lack of trust that really presents the biggest threat.

[Winstonm]

It is this lack of trust that really presents the biggest threat.

 

There is a lot of wisdom in this statement. And it appears most everyone involved has lost a degree - the ratings agencies, Moodys, Fitch, S&P, the monoline insurance companies, Ambac and MBIA, the government's spokepersons assuring us that "subprime was contained".

 

Fool me once.....

[Winstonm]

Bear-Stearns will BK, regardless of interventions. I've read that a deal has to be finalized by Monday. There simply isn't enough time for buyers to evaluate the potential losses in the derivative exposure of the Bear hedge book, IMO.

Confirming what I said, Reuters is reporting the Bear-Stearns is close to a deal to be purchased but.....

 

A stumbling block in any deal is the amount of risk JPMorgan Chase would be taking on, the Wall Street Journal reported. The bank is looking for assurances that would limit its liabilities in taking on Bear Stearns, the newspaper said, citing people familiar with the matter.

 

So JP Morgan wants to buy everything but possible losses...hell of a deal if you can get away with it.

[whereagles]

So, the government stepped in and used tax payer's money (i.e. everybody's money) to cover up for Bear-Stearns management blunders.

 

irony Sounds fair to me... /irony

[barmar]

Is it really a BS management blunder, or a widespread economic problem that happened to hit BS especially severely. And perhaps if BS were allowed to fail, there could be a domino effect on the industry.

 

Is there much of a difference between this bailout and the Chrysler bailout 30 years ago?

[Winstonm]

Holy Sh*t! Reports are coming out that J.P. Morgan Chase bought Bear-Stearns for $2 a share and didn't have to take all the debt.

 

Assume crash postions.

[hrothgar]

My understand is that J.P. Morgan is acting as an agent of of the Fed

 

I doubt that they would have wanted to buy Bear Stearns without some outside prooding

 

Krugman has a decent piece in todays NYT

[Al_U_Card]

Well wasn't it old J.P. himself that insisted on buying low.....?

 

I wonder what the asset balue of BS is? Likely closer to $2 per share plus all of the CDO debt and foreign obligations plus a nice premium to JPMC for doing the paperwork.

 

What a country! What an economy! What a future!