A couple of days ago, I posted about the obvious as to who eventfully will have to foot the bill if the Fed’s guarantee of JP Morgan’s purchase of Bear Stearns’ assets should prove to be a losing proposition.
MarketWatch featured a follow up story about the Fed’s partnership with JP Morgan. Here are some highlights:
The Federal Reserve has gone into business with J.P. Morgan Chase & Co. by taking effective ownership of $30 billion of the most toxic waste on Bear Stearns’ books.
In the latest groundbreaking move from the central bank, the New York Federal Reserve Bank will manage and dispose of the high-risk securities that helped push Bear Stearns Cos. over the brink and into the arms of J.P. Morgan.
If the securities, valued at $30 billion on March 14, sell for more than $30 billion, the Fed will take the profit. If they sell for less, J.P. Morgan will assume the first $1 billion in losses, with the Fed on the hook for the remaining $29 billion.
The details announced Monday are slightly more favorable to the Fed than the arrangement announced a week earlier, but, for many critics, the changes don’t amount to much more than putting lipstick on a pig.
…
J.P. Morgan will set up a limited liability company to hold the Bear Stearns assets, which will “ease administration of the portfolio and will remove constraints” on Blackrock Financial Management Inc., which has been hired to manage the portfolio “under guidelines established by the New York Fed to minimize disruption to financial markets and maximize recovery value.”
Blackrock will work for the New York Fed, not for J.P. Morgan.
J.P. Morgan will finance $1 billion on the debts. Financing on the other $29 billion will be extended by the Fed to J.P. Morgan at the discount rate, which is currently 2.5%.
Repayment of the Fed’s loan should begin in two years, the Fed said.
For many analysts, the fundamentals of the transaction remain unchanged: gains on Wall Street are privatized while losses are socialized.
The last sentence pretty much sums it up. If there are losses, the taxpayer will take the hit, if there are gains, the government will keep them.
Looking at the big picture, however, I feel like I’m stuck in this dichotomy: On one side, in a capitalistic society, a failing enterprise should be allowed to fail and the market place will sort things out without any government intervention or involvement.
On the other side, you could make the argument that if a failing enterprise, such as Bear Stearns, with its non-transparent assets and financial intertwinement with many banks and other institutions, poses a potential risk of causing the financial system to collapse, then intervention might be warranted.
The speed, with which the Fed stepped in to lend a helping hand, makes me believe that we were close to a financial collapse with a potentially incalculable domino effect, which was avoided for the time being.
The question in my mind remains as to whether an intervention is justified given the circumstances as described. What’s your view?
Comments 3
In the second half of 2007 the FHL Banks were the option of choice for stemming the tide of crashing mortgage default values. They rescued Countrywide, WaMu jumped in feet first, and Wachovia held out their hands as well.
It was just about the end of November last year, when the pace of financial and consumer discretionary sectors dumping into oblivion really took off, that we began to hear that phrase, “…socialism for the rich…”
FHLB proved insufficient (as most knew it would) and in my view we’re now at the last stand. Unless people begin to rush in and buy houses again and perk up prices there will be more Bear Stears coming. Where are people going to get the money to start buying houses again? I have an idea…
…they could sell off all the collector cars they’ve been purchasing via Barrett-Jackson over-hyped auction outlets (crashing the collector car market).
I heard the other day that the B-J auctions have been seeing more “new” buyers purchasing at their auctions and fewer sales to well-established buyers, the usual suspects if you will. B-J played this off as “healthy for the market.” But in my view this is a sure sign that yet another asset-class bubble is about to burst.
I wonder how much of the collector car market ascension has been due to easy money loans from the very same banks that can’t get payments from mortgage holders.
A little off topic but it’s Saturday…
G.H.
I’ve thought all along that the Fed’s actions have been designed to save the system, not bailout individual banks or firms.
A Bear Stearns collapse would have cascaded through the system as hundreds of billions of leverage unwound in chaotic fashion over night. The economic and systemic damage would have been profound.
It appears that the Fed’s actions are allowing the leverage to be unwound in a semi-controlled fashion.
Too soon to say, however, if the Fed will be entirely successful in averting a catastrophe. Still too many unknowns.
Some day, very interesting books will be written about this episode of financial history.
This is a tough one. We can’t really know what the fallout would have been because it didn’t happen. I’m inclined to believe that they should have let it go. Bear was levered at about 33x it’s assets I read, and over 40x last year when the hedge funds had to be bailed out. Want to talk about “systemic risk”? That’s where it is IMHO, these investment banks are levered out the wazoo. They’re causing the problem with these wreckless business practices. It may hurt financial institutions, but the system needs to be purged of all this kind of insanity. Sometimes a collosal train wreck is the only way to get these problems fixed. What lesson was learned by the rest of Wall Street with Bear? Are they going to change their behavior for the better now? I think not… They now know they have the Fed put in place.