Property Grunt

Sunday, March 16, 2008

Spit and Bailing wire

This picture of Kelly Kreth has nothing to do with this entry. But I put it up since she demanded it for putting up Julia's picture. There will another in the future.

The big news of last week besides Eliot Spizter stepping down and Julia Allison’s marshmallow fetish was Bear Stearns emergency infusion of cash from JP Morgan Chase and the Fed. There were rumors that Bear Stearns was actually about to go under which of course Bear Stearns denied. It appears those rumors were closer to the truth than they liked.

We are entering an entirely different theater, which requires a new set of firing solutions. It appears the Fed is very well aware of the situation which is illustrated by their actions.

According to the New York Times.

On Friday, the Federal Reserve seemed to toss out the rule book altogether when it assumed the role of white knight, temporarily bailing out Bear Stearns, one of Wall Street’s biggest firms, with a short-term loan to help avoid a collapse that might send other dominoes falling.

That move came just days after the Fed announced a $200 billion lending program for investment banks and a $100 billion credit line for banks and thrifts. In a move that would have been unthinkable until recently, the central bank agreed to accept potentially risky mortgage-backed securities as collateral.

Gretchen Morgenson puts in her two cents about why this is good and bad.

“Why not set an example of Bear Stearns, the guys who have this record of dog-eat-dog, we’re brass knuckles, we’re tough?” asked William A. Fleckenstein, president of Fleckenstein Capital in Issaquah, Wash., and co-author with Fred Sheehan of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.” “This is the perfect time to set an example, but they are not interested in setting an example. We are Bailout Nation.”

And so we are. After years of never allowing any of our financial institutions to fail, they have become so enormous that nobody will be allowed to sink beneath the waves. Otherwise, a tsunami would swamp the hedge funds, banks and other brokerage firms that remain afloat.

If Bear Stearns failed, for example, it would result in a wholesale dumping of mortgage securities and other assets onto a market that is frozen and where buyers are in hiding. This fire sale would force surviving institutions carrying the same types of securities on their books to mark down their positions, generating more margin calls and creating more failures.

Remember that story I told you about Rupert Murdoch when back in the 80’s he was so over leveraged that not only could he not make his payments but had to actually has to ask for more money? The banks were rather unhappy about the situation and one bank was about to pull the plug that would have sent everything in a freefall.

It is the same situation but different players. The Fed realizes that the survival of the economy hinges on these financial institutions. The general consensus is that these entities need to accept the consequences for their actions. Unfortunately, those consequences would probably affect us all.

As Gretchen Morgensen puts it

HERE is the bind the Fed is in: Like the boy who puts his finger in the dike to keep sea water from pouring in, the Fed finds that new leaks keep emerging.
Regulators must do whatever they can to keep the markets open and operating, and much of that relies upon the confidence of investors. But by offering to backstop firms like Bear, who were the very architects of their own — and the market’s — current problems, overseers like the Fed undermine a little bit more of that confidence.
Another worry? How many well-capitalized institutions remain at the ready to take over those firms that may encounter turbulence in the future? Banks just do not have the capital that is needed to rescue troubled firms. That will leave the taxpayer, alas. As usual.

This morning Treasury Secretary Henry Paulson was on This Week with George Stephanopolous basically stating the party line which was the following:

The government is prepared to do what it takes" to ease turmoil in the financial system and minimize any damage to the national economy, Paulson said during a series of broadcast interviews. The Fed's intervention "was not a difficult decision. It was the right decision."

"Well, our financial institutions, our banks and investments banks are very strong," he said. "And I'm convinced that they're going to come out of this situation very strong."

The financial system, he said, is "more fragile than we would like right now."

My impression of Mr. Paulson was that he was extremely calm in fact too calm for my taste. It appears that he was making twice the effort to emote that everything was cool as Pulp Fiction. Bush has done the same thing, trying to reassure the people that we are going to be fine.

This is an election year, the current administration is on its farewell tour and they have more than enough problems to deal with. Which means they have nothing to lose and they do not want to add more to their workload. So they are going to slap on as many bandages on the economy as they can. Of course these are temporary fixes because the wounds that have been inflicted on the economy are not cuts and bruises but are actually sucking chest wounds. The possibility also looms that these solutions may make things worse down the road.

But guess what? In 9 months, it is going to be someone else’s problem. Remember the last election? When Greenspan was running things, did you see him do anything out of the ordinary? Hell’s no. He was going to maintain the status quo till the dust settled and he saw who was going to be the last man standing.

I suspect Bernanke is following the same game plan. This is simply a stopgap measure. For all we know Bear Stearns got this infusion not to rebuild and restructure itself but to give them time to put their affairs in order before heading to the hospice.

It appears that Bear Stearns shall live another day. Under the banner of JP Morgan Chase and with a more than a little help from Uncle Sugar.

Federal Reserve Acts to Rescue U.S. Financial Markets

Hoping to stabilize financial markets, the Fed approved a $30 billion loan for the takeover of Bear Stearns and announced a new lending tool for major investment firms.

JPMorgan Chase Buying Bear Stearns for $2 a Share

In the deal crafted on Sunday for Bear Stearns, JPMorgan Chase agreed to pay a mere $2 a share for Bear — less than one-tenth the firm’s market price on Friday. As part of the deal, JPMorgan and the Federal Reserve will guarantee the enormous trading obligations of the troubled firm, which was driven to the brink of bankruptcy by what amounted to a bank run.

What a bargain!