Bear Stearns Roundup
Jesse Walker | March 17, 2008, 11:18am
Megan McArdle:
A couple of years ago, I had dinner with an investment banker who had gone to Chicago a few years before I did. He spent a great deal of the time extolling the virtues of modern markets, proclaiming that over the last ten years, we'd become massively better at pricing risk.
Being a great fan of John Kenneth Galbraith's work on asset-price bubbles, I felt the hair go up on the back of my neck. "Are we really better at it?" I asked. "Or do we just think we are?"
"No, we're really better," he assured me. Ooops.
Sheldon Richman:
The subprime problem has its roots in pro-business government intervention; the policies at fault were designed to help the housing industry and the lenders who write mortgages. Now the other shoe is falling. Big lenders and investors handling securitized mortgages who are in over their heads will get their promised bailout under the "too big to fail" doctrine. And the rescue will set the table for the next round of bad business decisions and the next bailout. It's called moral hazard.
What does this have to do with the free market? As Kevin Carson likes to say, if this is the free market, then I'm against it. Of course, it is not the free market. The free market is a profit and loss system void of privilege. When businesses fail, they are supposed to actually fail, not turn to the taxpayers.
Jay Hancock:
Market purists gasped when the British government nationalized mortgage lender Northern Rock last month. But how would you describe tonight's Bear Stearns bailout? It wears the costume of a market transaction. JP Morgan is "buying" Bear for $2 a share. But the Federal Reserve is taking the unprecedented step of seizing control of Bear's investment portfolio. And it is giving JP Morgan Chase a $30 billion loan to take Bear over. So the Fed is simultaneously financing the deal and managing the workout. Why not end the charade and hand Ben Bernanke the keys?
Sudha Shenoy:
Federal Reserve officials twisted J P Morgan's arms -- which was why the latter 'agreed' to buy. Officials had to provide Morgan's with a loan & a guarantee against the weakest ‘investments' -- bad mortgages -- in the Bear Stearns portfolio. These dubious liabilities amount to some $US 33,000 million -- or some 138% of its total purchase price. Thus its unsound investments are one reason for the very very low price that Bear Stearns' shareholders received -- even from J P Morgan's & even after a Federal loan + guarantee.
In the absence of Federal Reserve intervention & arm-twisting, Bear Stearns would undoubtedly have had to cease trading. And no doubt it would've been taken over, eventually -- at an even lower price. All that govt officials could do was to shorten this time period, & possibly prevent Bear Stearns' value from falling even further. But even the almighty Federal Reserve -- the world's largest & most powerful central bank -- could not prevent the huge capital losses that Bear Stearns' shareholders suffered. In short, even the Fed could not stop the de facto failure of one of the world's largest investment companies.
Russ R | March 18, 2008, 11:25am | #
Fred... a couple of points for clarification:
"And yet the Dow ended up 21 points today. Up!?"
The Dow Jones Industrial Average is very narrow market index. The Dow was up yesterday because one of the 30 stocks in the index, JP Morgan Chase, managed to buy Bear Stearns, a company worth about $11 billion dollars in book value for only $237 million, or about 2 cents on the dollar.
Write down as much mortgage debt as you like, but any way you slice it, that's still one outstanding deal for JPM. The market recognized this, and bid its stock up 12% on the day, when almost every other bank, brokerage and financial institution was down hard.
That's why the Dow was up. Look at a broader market index, like the Standard & Poors 500, and it will better reflect the negative sentiment.
"Just when it's been revealed that the fifth biggest investment bank was worth only $2 a share."
Not quite. Bear Stearns was not worth $2 a share... they found themselves in a situation where they had to make a deal with anyone who could provide them the capital they needed to stay alive, and they had to take the only offer they had. Basically, the reason they sold for only $2 is because Jamie Dimon could name any price he was willing to pay, and nobody was in any position to argue.
The market is already trading BSC shares between $4 and $5. A long way down from the $57 it closed at on Thursday, but more than double what JPM has offered. This implies that there is a good chance that shareholders will vote against the deal, and management will either find another bidder, or conduct a more orderly liquidation / restructuring that will realize more value than they could negotiate amid a liquidity crisis.
"What's a liquidity crisis?"
Here's an analogy:
Imagine you and your wife have a very nice home that you've nearly paid off, and $10,000 of investments in your brokerage account. You're about to sell off the investments, and use the cash to finally pay off the last $10,000 of your mortgage loan, which is due at the end of the day.
You and your wife drive to your broker's office mid-afternoon, only to find that your investments have declined in value, and are only worth $5,000. If you don't pay the mortgage lender in 2 hours, they foreclose your half-million dollar home, and your wife is going to kill you.
Where on earth are you going to get $5000 in the next 2 hours? You don't have any more cash available, nobody will lend you the money, and the value of your investments isn't miraculously going to double. Only one choice remains, sell the car.
Now, your vintage roadster is worth at least $25,000 but to get someone to buy it on the spot, without a chance to test-drive it, check the records, all of that, you're going to have to offer them a serious bargain. The used car dealership next door to the broker offers you $6000, cash. You don't have time to seek out other buyers. So you grit your teeth and hand over the keys, under the stern gaze of your extremely annoyed wife.
That's a liquidity crisis, and it's pretty much what Bear Stearns faced over the weekend, except, the investment account was a portfolio of sub-prime mortgage securities, the vintage roadster was the equity in their company, the home they nearly lost was the the integrity of the global banking system, and the wife was the Federal Reserve.
Hope that helps.
