The news that Bear had to run to the Fed for help with its rapidly deteriorating cash position, and JP Morgan has been muscled into assisting in the rescue is a sign that Bear was deemed too big to fail. The Fed is lending against Bear’s collateral (I haven’t seen an estimate as to how large this operation is).
First Countrywide, now Bear. Why did the Fed not let Bear collapse? You can attribute it to the Fed’s tendency to take responsibility for problems it can’t and shouldn’t fix, but this one is a trickier call than Countrywide.
Bear is a large prime broker, which means it lends to hedge funds. It is also a significant counterparty in enough different credit markets that its collapse would have at a minimum caused panic as to who might have been hurt. You’d have a further scramble for liquidity and reluctance to lend, which is precisely the condition the Fed has been trying to alleviate.
In particular, according to Bloomberg, Bear was the second largest underwriter of mortgage bonds, The lead manager (I’m assuming Bear was also a significant lead manager) is the only one who knows where the bonds went and is thus in the best position to trade them. So Bear’s role as an important market-maker may have played into the calculus.
But the answer to the question of whether Bear should have been allowed to tank depends on how long it would take the crisis to pass. Swap spreads were elevated a full year after the LTCM rescue, but here the relevant metric would be how long the acute phase might take. If it was two weeks or a month, and no one save maybe some middling sized hedge funds (or a lot of teeny ones) would fail, that would have been acceptable. But the Fed couldn’t assess this in a 24 hour period. (However, some parties believe that the Fed’s $200 million TLSF was in part to assist Bear; if so, they’ve had at least a week to evaluate this risk. But in that case, I’m not certain they asked the right questions).
I still think Bear should have been permitted to fail. Now every the same size or larger knows the Fed will ride into the rescue. This is a terrible precedent. It also increases the odds of the Fed running out of firepower long before the crisis is over.
I also wonder what Bear employees were paid in bonuses last year (I assume the checks went out in late December or January) and whether cutting that number by 50% would have saved Bear’s hide. (CEO Alan Schwartz’s blaming the crisis on “market rumors is classic and should be heavily discounted, although one also has to wonder if Bear would have survived if the TSLF had been operational this week).
Analysts believe that JP Morgan may wind up owning parts or all of Bear. It isn’t easy to hive off pieces of trading firms, which Bear is. As we have said before, Bear has such a sharp-elbowed, entrepreneurial culture that it’s difficult imagining that anyone could manage it successfully, This bailout (which is almost certain to leave the banks owning Bear, given the dearth of other capable and interested parties) has high odds of being a value destroying exercise for JP Morgan.
For the curious, Bloomberg also describes how the Fed has the authority to rescue a non-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 allows it to loan 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.”
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It’s wrong to assume JP Morgan’s intervention is due to interest in a Bear Stearns takeover. It’s actually because Bear isn’t a bank and thus doesn’t have access to the discount window.
The plan is to bail them out, via JPM until the new Fed funding scheme starts in circa 25 days when they will then be included due to their status as a primary dealer.
Problem now is no one will be able to deal with Bear so they’re now probably screwed!
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On comp, everyone already took a 40% haircut today on the 50% plus equity component. Is is Easter season, have some omercy ther firm is RIP. 20% cut seems like a great deal until you realize it was a balloon payout.
Bear downgraded as a counterparty and hence their cost of funds just got more expensive and BV is deteriorating by the moment. Lazard better get this thing sold fast becasue by monday it is going to look like a brand new Mercedes exiting the chop shop. I imagine all the top bankers etc are fielding calls today.
Either bear gets sold before asia opens or the fed cuts over the weekend. Anyway you cut it a very scary time to go into the weekend long.
Yves,
Allowing Bear to margin liquidate from mostly mark-to-market losses (so far) would have been a disaster of epic magnitude, triggering a domino effect wiping out half the street and effectively ending any hope of recovery of credit markets anytime soon.
Mark my words, this day when the Street finally realized that they have to help each other or else they all go down will signal the turning point in this crisis (not saying markets won’t go down further in the short-term).
Rich
I wonder if Warsh was at the meeting, or if he was out to lunch shopping for toys?
Yeah I’m not sure if “bailout” is the right word when applied to Bear. Bear is finished as an independent firm; at least I’d be very surprised if they survive. What it is, as commented above, is a bailout for others on Wall Street. It would have been wipe-out time had BS just gone done without any assistance. Mind you, it’s only a matter of time before Lehman or Citi hit the wall now, so even for Wall Street, it’s not so much a question of if, but when.
I think the point about bonuses cannot be shouted loudly enough. The bonuses paid for 2007 were criminal. The IBs knew it, but the pigs that they are couldn’t refuse one last gulp at the trough.
“I think the point about bonuses cannot be shouted loudly enough. The bonuses paid for 2007 were criminal. The IBs knew it, but the pigs that they are couldn’t refuse one last gulp at the trough.”
Hmmm! They went after Grasso for his compensation. I wonder if the same will happen for the IBs.
Should shareholders’ lawsuits proceed, the discovery process could reveal very interesting things indeed.
Nice old story here worth reading!
The Education of Ben Bernanke
http://www.nytimes.com/2008/01/20/magazine/20Ben-Bernanke-t.html?_r=1&pagewanted=8&oref=slogin
Soon after Bernanke’s speech in May, two hedge funds organized by Bear Stearns reported huge mortgage-related losses. Credit markets were suddenly jittery. When the committee met on Aug. 7, many expected it to give markets a little relief by easing the fed funds rate, then at 5.25 percent.
On Friday, Aug. 10, the New York Fed pumped $38 billion into the markets, several times as much as on a normal Friday. Meanwhile, some of the governors, as well as William Dudley, a former Goldman Sachs economist and now the markets chief of the New York Fed, were canvassing C.E.O.’s, bank executives, traders and the like. Warsh, who was dialing contacts from his Wall Street days, was alarmed by what he heard. A source he described as a “hedge-fund billionaire” told him that credit assets weren’t trading; people didn’t want them at any price. “Markets weren’t functioning,” he says. “That is very dangerous for a central banker to hear.”
Guess Warsh as a Wall Street connection is kinda in doubt here?
Sorry, wanted to add this in to the above: Bernanke has no ego about such matters, and he consulted extensively with Timothy Geithner, the president of the New York Fed, as well as with Kevin Warsh, a fast-rising 37-year-old Fed governor and former investment banker at Morgan Stanley, whose unofficial role is to keep tabs on Wall Street.
This situation is reminiscent of Richard Bookstaber’s observation, that the modern financial system is now “tightly coupled” like a nuclear reactor. A lot of little processes have to operate correctly within fairly narrow parameters. Fairly minor things going awry can have systemic consequences.
The reason I said it would have been good for Bear to fail was two-fold, The first was moral hazard. However, now that it looks pretty certain that Bear is not going to survive as an independent firm, and may well be liquidated on an orderly basis, a la LTCM, pretty much eliminates the moral hazard issue.
However, we still have the second problem that this is still relatively early in the underlying mortgage crisis. We simply won’t know how bad the defaults and recoveries will be until at least well into 2009, perhaps later. But the wheels have already started coming off the financial system. It has a lot more shocks to endure before we are through this mess.
Check this out yves!!!!
Let me just conclude by saying that the terms of the rescue package engendered by the Fed also raise troubling questions of financial concentration and antitrust. As a group working together, the new owners can have a greater impact on markets than in competition with one another. In this regard, it should be understood that the Fed’s unprecedented extension of the too-big-to-fail doctrine to a hedge fund does not insulate the fund and its new owners from the constraints of the Sherman and Clayton acts.
The bailout may involve a tendency toward concentration that the Justice Department has an obligation to review.
HEDGE FUND OPERATIONS
THURSDAY, OCTOBER 1, 1998
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.
http://commdocs.house.gov/commit…/ hba51526_0.HTM
The Fed really had no choice. This bailout isn’t for the benefit of Bear’s management or shareholders; it’s for the benefit of Bear’s counterparties. The Fed can’t allow counterparty risk panic to freeze the credit market even further, not at this critical point when things were seizing up again, which the TSLF was supposed to fix.
I wonder if Bear was hit by the “Carlyle Capital effect”. The TSLF probably had the perverse effect of killing Carlyle Capital, the exact opposite of what was intended (Robert Peston @ BBC, via Alea). The TSLF gave creditors every incentive to seize Carlyle Capital’s collateral in order to present it at the Fed window in exchange for “lovely liquid Treasuries”, something which Carlyle Capital itself couldn’t do. Bear, on the other hand, is allowed to use the TSLF… but the TSLF doesn’t go live until March 27.
This suggests two things: first, the Bear bailout is much less significant than meets the eye, because it’s just a Bear-only jumpstart to the TSLF which would have saved Bear anyway. In other words, it’s nothing really new or different from the TSLF itself.
And secondly, an awful conspiracy theory presents itself: were Bear’s creditors trying to deliberately hasten its demise (a la Carlyle) before Bear could take advantage of the TSLF, so they could grab Bear’s collateral and turn it into desperately needed liquidity for themselves?
Bernanke must be truly annoyed, because today’s Bear debacle rather spoiled the carefully orchestrated impact of the TSLF rollout. Perhaps he needs to send an envoy to Bear’s creditors to softly suggest to them to never, ever do such a thing again.
I hear Eliot Spitzer is looking for a job…
This is the standard model of the American Corporation:
Privatize the profits-
Socialize the risk.
Why should they risk anything, they are the elite?
If the Fed is going to offer a lifeline to a non-bank (or any bank for that matter), it should also get a call option on the institution. That way, if this does in fact turn out to be just a short term liquidity issue for Bear, the Fed will get the upside – not shareholders or management.
If the crisis turns out to be a genuine solvency issue, the Fed would then have time to analyze the assets and determine whether the situation was so dire that a public bailout would be necessary.
Counterparties might even gain confidence in the entity with the potential for a Fed, deep pocket, takeover.