On the Bear Stearns Situation
There were some fast-moving developments in the Bear Stearns situation.
Pushed to the brink of collapse by the mortgage crisis, Bear Stearns Cos. agreed -- after prodding by the federal government -- to be sold to J.P. Morgan Chase & Co. for the fire-sale price of $2 a share in stock, or about $236 million.Bear Stearns had a stock-market value of about $3.5 billion as of Friday -- and was worth $20 billion in January 2007. But the crisis of confidence that swept the firm and fueled a customer exodus in recent days left Bear Stearns with a horrible choice: sell the firm -- at any price -- to a big bank willing to assume its trading obligations or file for bankruptcy.
"At the end of the day, what Bear Stearns was looking at was either taking $2 a share or going bust," said one person involved in the negotiations. "Those were the only options."
To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns's less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn't describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.
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Former Treasury Secretary Robert Rubin last week described the situation as "uncharted waters," a view echoed privately by top government officials. Those officials have been scrambling to come up with new tools because the old ones aren't suited for this 21st-century crisis, in which financial innovation has rendered many institutions not "too big too fail," but "too interconnected to be allowed to fail suddenly."
Let's make some observations:
-- For all practical purposes, Bear Stearns is bankrupt. Despite the shotgun nature of the Bear/JP Morgan deal, Bear would not have agreed to a $2/share valuation unless the damage to their business was extremely severe.
-- JPM swooped in quickly on this deal. My guess is they have been watching this situation for some time and waited for the right moment to get this deal. All the players lined up too quickly in JPM's favor for this to be a happy coincidence. JPM sees a play here and went for it. This actually is good news. If there are other firms in financial straights right now, others know about it. The Fed has demonstrated they will help to finance the deal. In short, if another firm goes bankrupt it will be a quick procedure to deal with it.
-- The Federal Reserve is scared shitless. There is no reason for them to get involved in this deal unless they were worried about one of two things (and probably both): 1.) the ripple effect and/or 2.) other banks in a similar situation. The Fed is looking for any tool (and making some new ones up) to prevent a system wide crisis.
-- Last week S&P announced the end of the writedowns at the big banks was near an end. Almost on cue, events demonstrated how hapless S&P has become when it comes to credit analysis.
To combat further problems, the Fed has lowered the discount rate and expanded its credit facilities.:
The Federal Reserve, struggling to prevent a meltdown in financial markets, cut the rate on direct loans to banks and became lender of last resort to the biggest dealers in U.S. government bonds.In its first weekend emergency action in almost three decades, the central bank lowered the so-called discount rate by a quarter of a percentage point to 3.25 percent. The Fed also will lend to the 20 firms that buy Treasury securities directly from it. In a further step, the Fed will provide up to $30 billion to JPMorgan Chase & Co. to help it finance the purchase of Bear Stearns Cos. after a run on Wall Street's fifth-largest securities firm.
``It is a serious extension of putting the Federal Reserve's balance sheet in harm's way,'' said Vincent Reinhart, former director of the Division of Monetary Affairs at the Fed and now a scholar at the American Enterprise Institute in Washington. ``That's got to tell you the economy is in a pretty precarious state.''
The move is Chairman Ben S. Bernanke's latest step to alleviate a seven-month credit squeeze that's probably pushed the U.S. into a recession. The dollar tumbled to a 12-year low against the yen and Treasury notes rallied as traders increased bets that officials will reduce their main rate by 1 percentage point when they meet tomorrow.
`Race to the Bottom'
``Clearly, the Fed is trying to provide more liquidity to prevent a more vicious cycle and race to the bottom,'' said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, which oversees $200 billion. ``The problem is there's so much concern about credit quality that now there are solvency issues, and it's something the Fed has a more difficult time dealing with.''
I was listening to Bloomberg this morning and someone commented that Bernanke is a student of the great depression and that knowledge was serving him well. I agree with that sentiment. I have made a great deal of fun at Bernanke's expense over the past few months. Frankly, I feel a great deal of empathy for him because he is between a rock and hard place.
However, I understand his reasoning for taking these moves. Simply put, Bernanke is trying to prevent a financial sector meltdown.
The central problem the Fed faces right now is their tools are not designed for the problems we face. What we have right now is a collateral and counter-party crisis. That means two things.
1.) The collateral crisis means that collateral on bank's balance sheets isn't performing as well as advertised. Basically, any bond backed by mortgages is in trouble because homeowners aren't paying their mortgages. That means banks who hold mortgages aren't getting the payments they should be getting. As a result, banks balance sheets -- which serve as the basis for their ability to extend credit -- are in serious trouble. That means...
2.) Anyone who might take out a loan might not pay it back. This is called counter-party risk. It simply means that everyone is at risk of defaulting on a loan right now. That means loans aren't getting made. In an economy like the US economy where credit is a prerequisite to everything, that is the kiss of death.
The Fed can provide plenty of money. Over the last 9 months they have flooded the market with cash. But that does not good if people aren't willing to use it. And right now, no one wants to loan anybody any money. That's the central problem -- and so long as that exists there will be a mis-match between the Fed's policy tools and the market's problems.
Let's look to the future:
This week Bear, Goldman Sachs (GS), Lehman Brothers (LEH) and Morgan Stanley (MS) are slated to report results for their first quarter, ended in February. The results won't be pretty.
The new name on everybody's lips is Lehman Brothers:
Lehman Brothers Holdings Inc. Monday said the bank's liquidity position remains strong, as the fire sale of Bear Stearns to J.P. Morgan to prevent bankruptcy increased speculation that other big U.S. brokerages would come under pressure.But who am I to say what's goin on in our country? I can barely balance my checkbook. Don't just take my word for it, since in the immortal words of Tango and Cash, I "don know shit.""Our liquidity position is and continues to be strong," said Matthew Russell, head of corporate communications for Lehman Brothers Asia Pacific.
His statement came after people familiar with the situation said DBS Group Holdings, Southeast Asia's biggest bank by market capitalization, has asked several traders not to enter new transactions with Lehman Brothers.
"DBS has sent an internal e-mail saying it would not deal with Lehman Brothers from now on. It said DBS shouldn't enter into new dealings with Lehman or Bear Stearns," one person said. Another person said that the email didn't mention anything about closing existing positions with Lehman, which appear to remain in place for now.
DBS's move follows the near-collapse of Bear Stearns Cos. Friday, a similar pullback by counterparties caused the bank's liquidity to dry up. J.P. Morgan Chase & Co. Monday agreed to buy Bear Stearns for $2 a share in a bid to avert a bankruptcy by the U.S. investment bank. (See related article).
Think Progress: White House Defends Bailout Of Wall Street Instead Of Main Street
During today's news briefing, reporters questioned White House Press Secretary Dana Perino on the Fed's actions, noting that the White House has repeatedly refused to extend similar assistance to homeowners facing foreclosure. Perino replied that help to homeowners -- a "boost of liquidity" -- would come "in the form of a stimulus package and a tax rebate."The average rebate check will amount to about $600 for single people and $1,670 for middle income families. Compare this figure to the nationwide median mortgage payment, which stood at $1,566 in September. Or to the average increase in subprime mortgage payments in early 2007, which was $320 per month. These checks obviously won't help Americans stave off foreclosure -- a frightening reality facing an increasing number of people. Foreclosure rates skyrocketed 60 percent last month from February 2007, and Americans own less equity in their homes than they have since World War II.
Read more and watch the video of Perino's comments here.
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New York Times: Fears That Bear Sterns Downfall May Spread
The cash squeeze that brought Bear Stearns to its knees is fanning fears that other investment banks might be vulnerable to the crisis of confidence gripping Wall Street.Investors are bracing for another volatile week in the markets as bankers and policy makers deal with the fallout from their bid to rescue Bear Stearns. For now, the prospect of a new wave of consolidation in the beleaguered financial services industry seems remote. That is because would-be acquirers and everyday investors alike have lost faith in the values that Wall Street firms are placing on their own assets. Of particular concern are the so-called marks placed on mortgage-linked
investments like those that undid Bear Stearns, prompting a run on the firm that led the Federal Reserve and JPMorgan Chase to throw Bear Stearns a financial lifeline last week. James E. Cayne, the chairman of Bear Stearns, mused eight years ago that he might consider selling the 85-year-old bank for a lofty price of four times what it values itself on its books. But now such a notion seems absurd -- and not just for Bear Stearns. The unhappy experience of Bear Stearns proves that it is a lack of confidence, not capital, that ultimately topples even the savviest financial institutions. "Once you have a run on the bank you are in a death spiral and your assets become worthless," said David Trone, a brokerage analyst at Fox Pitt Kelton. In all-day meetings over the weekend, Alan D. Schwartz, the chief executive of Bear Stearns, met with his top executives at the firm's Madison Avenue headquarters, trying desperately to persuade skeptical potential suitors that the firm was worth buying. But the market had already passed a harsh judgment on Bear Stearns. On Friday, its stock plunged 47 percent, closing at $30. At that price, its shares were trading at a gaping 62 percent discount to the $80 book value that the firm has reported, reflecting the broad view that the fallout from the credit crisis had permanently devastated Bear Stearns's core mortgage operations.
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New York Times: Dow Ends Flat After Day Of Gyrations
A day that loomed darkly on Wall Street ended with only a modest decline in the overall market and the Dow Jones industrials in an unlikely place: positive territory.A floor trader at the Hong Kong Stock Exchange on Monday. More Photos » The Dow finished up 21 points after gyrating wildly through much of the session, from a loss of almost 200 points to a gain of 100, in one of the most volatile trading days in months. But shares of most financial firms plummeted as one of Wall Street's most storied banks, Bear Stearns, lay on its deathbed and central bankers scrambled to stave off a devastating crisis of confidence in the financial world.
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AP: Fed Primed To Aggressively Cut Key Interest Rate On Tuesday
The Federal Reserve is primed to aggressively cut a key interest rate even lower on Tuesday, racing to contain spreading financial fires that threaten an economic meltdown......"The Fed is on high alert -- something you don't see but once every quarter century; may be, in this case, since the Great Depression. This is a very unusual period," said Mark Zandi, chief economist at Moody's Economy.com... ...To limit the damage, Bernanke and his colleagues may ratchet down a key interest rate, now at 3 percent, by as much as a full percentage point, to 2 percent, which would put that rate at the lowest it has been since late 2004. Because that rate affects a wide range of rates charged to millions of consumer and businesses, it is the Fed's most potent tool for reviving economic activity.
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Reuters: Deepening Economic Slump Envelops Factory Sector
A spreading economic slowdown seeped into U.S. factory activity in February and March as waning demand more than offset the export benefits of a cheaper dollar, a series of reports on Monday showed.A Federal Reserve report on industrial output showed that factories were running at their slowest rate in more than two years during February while a key gauge of factory business in the Northeastern U.S. slumped to a record low in March. Taken together, the reports reinforced concern that the world's largest economy stalled during the first quarter and was in an actual downturn, though Bush administration officials refuse to concede a recession has started.
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AP: After Bear Sterns Rescue, Who's Next?
With a deal in place to save Bear Stearns from bankruptcy, the company's shares traded above the offer price Monday even as investors began turning a critical eye to other investment banks amid worries about how far the credit contagion could spread......With Bear Stearns seemingly gone, investors pondered who might be next. Lehman Brothers Holding Inc. stock fell more than 34 percent Monday, following a 15 percent drop on Friday amid concerns it might be facing similar liquidity issues. Lehman Chief Executive Richard Fuld denied Monday that the firm was having such problems.
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Reuters: Banks Face A "New World Order" After Bear Sterns Collapse: Report
Financial firms face a "new world order" after a weekend fire sale of Bear Stearns and the Federal Reserve's first emergency weekend meeting since 1979, research firm CreditSights said in a report on Monday.More industry consolidation and acquisitions may follow after JPMorgan Chase & Co (JPM.N) on Sunday said it was buying Bear Stearns (BSC.N) for $236 million, or $2 a share, a deep discount from the $30 price on Friday and record share price of about $172 last year... ...In the event of future consolidation, potential acquirers identified by CreditSights include JPMorganChase, Wells Fargo, US Bancorp, Goldman Sachs and Bank of America (BAC.N), once it works through its recent agreement to acquire Countrywide Financial Corp, (CFC.N) the largest U.S. mortgage lender.
Posted March 17, 2008 | 09:59 AM (EST)