Readers no doubt recall that the Federal Reserve loaned $30 billion to JP Morgan against certain Bear Stearns assets to, ahem, induce the bank to go forward with the deal. The arrangement got reworked on the fly, and in the end, the Fed loan was reduced to roughly $29 billion as JP Morgan agreed to assume $1.15 billion of risk. The assets were placed in a holding company to be managed by BlackRock.
There is a bit of disparity in the reports on the state of play. The Financial Times indicates that the Fed’s said the loan balance was adjusted last week. The central bank also indicated that the value of the assets was now $28.8 billion (or $28.9 billion, if you prefer Bloomberg’s story). Either way, the losses this quarter were conveniently roughly equal to the JP Morgan’s first loss position.
Even though mortgage-related securities fell this quarter by more than the amount of the markdown, but recall that the central bank did not take them on at quarter-end. As the Financial Times noted:
The Fed marked the securities in the portfolio to current market prices. Analysts said that when the Fed assumed the assets back in March, they were cheaply valued, which would explain why the portfolio remains relatively unchanged.
However, one aspect of the deal that some observers took issue with was that the value used for the assets for the purpose of the loan was Bear Stearns’ marks as of March 14, the Friday before the deal was cobbled together. Recall also the deal was renegotiated from a price of $2 per share to $10, and the Fed’s loan arrangements were revised during that period. Query why the collateral value was not based on a price the week of March 17.
Thus, there may be nothing amiss here, but the results so far look awfully convenient.
The Bloomberg article includes a wee bit of good news, that there was no use Primary Dealer Credit Facility:
The Fed also reported that it had no direct loans outstanding to bond dealers as of yesterday under a program aimed at easing the credit crisis.
Today’s lending figures indicate that Wall Street is using the Fed only as an emergency backstop, rather than as a continuing source of funding, said Macroeconomic Advisers LLC senior economist Brian Sack. Treasury Secretary Henry Paulson warned dealers and investors this week they shouldn’t operate as if Fed funds were “readily available.”
11 comments
Comments are closed.
The reference in the definition of fair value “price that would be received upon selling an asset if the transaction were to be conducted in an orderly market on the measurement date” is key. Note the reference to “orderly market”. We already know from earlier accounting directives that distressed markets are not considered orderly. This permits a continuation of mark to model under the pretense that we do not currently have orderly markets.
The cynical side of me says, c’mon, did anyone really expect the Fed to come out with a drastically reduced valuation. They would’ve had their heads handed to them if they did.
P.S. I can’t recall anyone contesting whether markets were orderly or not when asset values were appreciating. It’s the same as banks booking profits from recognizing reductions in their own debt valuations (in that case the markets are fair and orderly), yet keeping reduced assets on the balance sheets as level 3 assets (in those cases, nooo, the market must be unfair and disorderly). The double standard stinks to high heaven.
Now that the credit crisis is one year old, isn’t it time for the Fed to admit that no liquid secondary market ever existed for most structured products?
“Now that the credit crisis is one year old, isn’t it time for the Fed to admit that no liquid secondary market ever existed for most structured products?”
Well, how are you defining liquid? I can see some definitions where that might be true, but those would emphasise the depth of the liquidity and the maturity of the investor base, not what most people think of as liquidity itself – the ability to quickly and efficiently enter or exit a position. By most conventional indicators of liquidity (availability of quotes, bid/offer spreads, dealer overhang) most structured products did have a liquid secondary market in the bull years. Even in Europe, where the secondary market was much less developed and there were no indices, billions of euros worth of structured products were traded every day. Clearly some sectors, especially CDOs and sub-investment grade tranches in all asset classes, were never liquid in secondary, but I don’t think anyone ever claimed they were.
“CDOs and sub-investment grade tranches in all asset classes, were never liquid in secondary, but I don’t think anyone ever claimed they were.”
But doesn’t the whole pricing concept for CDOs assume liquid markets? In a reasonable model, wouldn’t the illiquidity problem alone reduce the value below that of the underlying assets?
Treasury Secretary Henry Paulson warned dealers and investors this week they shouldn’t operate as if Fed funds were “readily available.”
Wink, Wink.
Given how the Fed’s concocted inflation numbers, did you really expect something credible?!
It looks pretty clear that the 10 Usd per share paid to BS shareholders was money that should have gone to backstop this portfolio of BS assets. (I presume people have noted many times that BS can mean both Bear Stearns and bullsh**.) But in America’s system of crony capitalism, one needs to ensure that the government pays off the capitalists.
I would also like to know the answer to the question whether the portfolio can have a negative value? It seems to me everyone assumes that there are no swaps in there, or no other instruments which can have negative value. Does anyone know?
YS:
You’re about as skeptical as I am. I immediately noticed the losses conveniently equalled JPMorgan’s capital contribution. As for the Fed’s valuation: what do I care what Helicopter Ben thinks the assets are worth. I didn’t audit his values. I have an idea though, sell them to Steve “Bigmouth” Schwartman at Blackstone for say $27 billion. We’ll see if he bites.
Ginger…having worked at two i-banks that were huge Cdo structurers, I can unequivocally say that purchasers were constantly assured that, especially for the AAA tranches, a secondary market did exist or the bank would make a market for them if necessary. That was the basis on which so many insurers, pension plans, even municipalities, got comfortable buying Cdo notes for their ‘alternative investment’ baskets into which almost anything that does not qualify as a standard stock/bond/other financial instrument can go.
And yes, the swaps that the i-banks did with Cdos (often hedging the AAA tranches or backstopping lower-rated tranches) can most definitely have negative values (meaning that the Cdo owes the bank money but is not presently expected to have the ability to pay it). I have heard that some banks have tried to securitize their portfolios of swap receivables linked to Cdos and sell them to various investors. Now that would be a fun call – if they cannot value them in-house – how do they expect investors to do so? Oh right…they will be rated AAA.
“But doesn’t the whole pricing concept for CDOs assume liquid markets? In a reasonable model, wouldn’t the illiquidity problem alone reduce the value below that of the underlying assets?”
Not for synthetic CDOs.
“I can unequivocally say that purchasers were constantly assured that, especially for the AAA tranches, a secondary market did exist or the bank would make a market for them if necessary.”
True enough, but I’m not sure an arranging agreeing to make a market is the same as claiming there’s a liquid secondary market. I’d agree that people probably assumed there was more liquidity at triple-A than there really was, but outside of SIVs which needed them to be liquid and in some cases ignored the dangers to maintain their yield, I’m not sure how many investors really considered them trading assets (note, I’m not talking trading vs banking book here).
Any bond indenture for a CDO of ABS states in the risk factors that no secondary market exists or may exist in the future.
Nearly all CDO of ABS was held in buy and hold portfolios. This was terrific until some wanted out, and until the impairments became obvious.
Deutsche Bank, Jan 2005, “Global CDO market 2004 overview”: `There remains only a limited two-way market for CDOs backed by structured product. The disconnect cannot exist indefinitely given how large the new issue market has become. We believe it is only a matter of time before holders of ABS CDOs will seek to opportunistically sell deals to either take profits or for other reasons.’
Again: the Fed is claiming abnormal conditions in a secondary market that barely if ever existed for CDO of ABS.