Posted on 03/29/2008 1:26:20 PM PDT by Ernest_at_the_Beach
Two days ago, I wrote here on the widely-reported $30 billion loan that the Federal Reserve made as part of brokering the acquisition of the Bear Stearns Companies by JP Morgan Chase (the "St. Patrick's Day Massacre").
I now have much more information on what this deal is all about. I guessed quite wrong about the deal structure. The $30 billion loan is not a term repo as I originally thought. Nor is it likely to generate monetary losses for taxpayers. (In fact, the opposite is true.)
But it is something bold and different that's worth understanding. In fact, it's a major milestone event in the monetary and financial history of the United States.
Before I launch into this, let me set the context by reminding you why all this financial mumbo-jumbo is important: it's because of politics. Even before the full effects of the credit crisis make themselves felt, we're already deeply into a paroxysm of "the sky is falling! What is the government going to do about it?" I'll be posting as much as I can on this subject in the coming days and weeks, because there is at least as much danger to the real economy from a mad dash toward new regulations and Federal involvement, as there is from the financial-system disorders themselves.
Keep reading...Some of my information comes from this somewhat-cryptic press release by the Federal Reserve Bank of New York, and some from private sources.
During the critical days of March 14, 15, and 16, while Morgan was madly trying to discern the outlines of what they were being asked to buy, they identified a portfolio of assets that they were not willing to finance. They asked for the Fed's help in guaranteeing the value of the portfolio. Several accounts agree that Bear Stearns hurriedly marked this portfolio to market as of March 14, producing a valuation of $30 billion, and the Fed agreed to lend this money to Morgan as a condition of agreeing to the acquisition.
Relatedly, it appears that the Fed (both the Reserve Board in Washington and the New York Fed that directly participated in the negotiations) was involved heavily in setting the lowball price of $2/share offered to Bear Stearns shareholders. (In interviews, Morgan CEO Jamie Dimon will only say that "a lot of factors were involved.") The Fed knew very, very well that the Bear deal would be perceived as a government bailout of a Wall Street firm, so they went out of their way to ensure a smackdown of Bear's shareholders.
How the public sees this is one thing. (The mendacious news media have done nothing to dispel the impression that the fatcats made out like bandits.) Much more importantly, however, the Fed sent Wall Streeters a brutally clear warning not to expect that they will be made whole the next time they get into trouble. The sight of Jimmy Cayne going from near-billionaire to 60-millionaire in just over a year will keep a lot of plutocrats under control for a long time to come.
At any rate, the Fed's $30 billion loan was announced as part of the acquisition on the evening of March 16 in New York. Over the following week, everyone got a chance to catch his breath and re-examine the asset portfolio that was guaranteed by the loan. And as a result, the Fed restructured that transaction. They announced the restructuring on March 24, and this is where things get really interesting.
The New York Fed has created a new limited-liability company, and they hired BlackRock Financial Management to run it. (BlackRock, the division of Merrill Lynch Investment Managers, not BlackStone, the publicly-owned private-equity firm.)
The New York Fed lent $29 billion to the new LLC, for a term of 10 years, which may be renewed at the Fed's option. Morgan put in $1 billion, in the form of a subordinated note. This is a key feature of the re-structured March 24 transaction, since in the original March 16 deal, the Fed was going to speak to the whole $30 billion.
The LLC will use the loan proceeds to acquire the Bear asset portfolio. And they plan to sell out the assets gradually as market conditions improve, over the next ten years or less.
Morgan's $1 billion note will take the first losses on the portfolio, if there are any. In essence, Morgan owns a 10-year call-spread on the deal, long at $29 billion and short at $30 billion. The first people to be paid out (after the LLC's operating expenses) will be the Fed. They get back their $29 billion, plus interest at the discount-window rate.
After the Fed get their money back with interest, Morgan will get back their $1 billion, plus interest at a rate equal to the Fed's discount rate plus 450 basis points (totalling 7% at the moment). That's the most that Morgan can make on the deal. Anything left after the principal and interest payments all goes to the Fed.
Depending on the liquidation value of the portfolio (which in turn depends on the original valuation and future market conditions), the New York Fed stands to make a significant amount of money here, well beyond their $29 billion investment.
Now there is still a big question mark: no one I've corresponded with knows for sure what the composition of the asset portfolio actually is. It appears to be a mixture of residential and commercial mortgage-backed securities, some with agency guarantees and some without.
And here is the key thing that makes this different from anything the Fed has ever done: the deal is essentially a trade. The New York Fed has funded the purchase of assets for a significant amount of time, in the full expectation that they will make a profit.
This is exactly the kind of deal that private actors like Bill Gross and Warren Buffett have been eyeing for months now. We do not know the specifics of the mark-to-market that Bear applied to the portfolio on March 14. It would be exceptionally interesting to know if they valued parts of it at 95 cents on the dollar, 70 cents, or somewhere else. Because the Fed's ratification of that valuation would put a floor under the MBS market as a whole, and potentially go a very long way toward resolving the overall credit crisis.
On the other hand, the New York Fed are very savvy traders. If they intend to make a profit with this vehicle, they don't necessarily want people to know their basis.
The transaction has been described by several of my correspondents as essentially a SIV ("structured investment vehicle"). This description strikes me as only superficially valid. A traditional SIV is dependent on continuous access to short-term repo funding, at low enough interest rates to finance the long-term paper held by the SIV. It therefore faces significant market and liquidity risk as interest rates move up and down.
I don't think the Fed's new LLC faces any risk that they will lose their short-term funding. (Even though there is mysterious language in the Fed's press release about an obligation of the LLC to pay the Fed interest at the current discount rate.) If anything, this is more like a hedge fund or a private equity fund than a SIV. I'd like to know if BlackRock got the standard two-and-twenty compensation structure for managing the vehicle.
To sum up, the New York Fed has entered the market for mortgage-backed securities as a direct participant, going far beyond their traditional role as a lender of last resort. This is a deeply significant and historic change, destined to have major repercussions. I've heard much apprehension and outright fear about the ultimate results, but so far, no one has been able to predict what they might be.
And in addition, many are questioning whether it needed to be done at all. In the days between March 16 and March 24, the Fed opened up its discount window to investment banks and broker-dealers. Some people believe the $30 billion probably could have been funded in the normal repo market after March 17, making the new 10-year LLC unnecessary. I'm not convinced of that.
Much of the general public is still going to react to this story as if the Fed has wantonly and illegally flushed $30 billion in tax money down the toilet. This sweet delusion will continue as long as the media can use it to sell fishwrap.
Forget about that. The real question, and the real danger, is: have the Fed embarked on an eyes-open strategy of direct participation in financial markets that will have extraordinary consequences?
We live in interesting times.
PAULSON DENIED ANY INVOLVEMENT IN THE DEAL!!! PAULSON NEEDS TO TAKE AN OATH THAT HE HAD NO INVOLVEMENT. Questions to be asked:In fact....I would like all of these questions to be asked at the April 3 hearings on this matter. The answers will be much more interesting when coming from Paulson, Bernanke, the Fed, and others.Why would anyone directly involved in the sub-prime fiasco at BSC get any compensation at all?
Why shouldn't they have to give back their compensation?
Why are they allowed to sell any stock at all?
Why shouldn't Bear Stearns' Chief Executive Jimmy Cayne be forced to rescind his stock to US taxpayers who will be footing $29 billion?
You explain....you’re the know-it-all, remember?
Maybe Travis can help, he's almost as confused as you are.
And, for the record, that question, at post #12, was never addressed to you for an answer to begin with. Furthermore, the question was never posed to any person on this forum to be answered. As it was posed, it was obvious, to any person with a brain, that it should be addressed, among other questions, to Paulson....who should be under oath when he makes statements concerning this matter.
Duh.
Travis already read the questions posted at #12.
The people making things up are you and groanup. I guess you’re the one who’s confused.
I would call it a rhetorical question, but I don't think the rhetoric is accurate. For one thing, Cayne was forced to rescind his stock, all but $2/share worth. He was forced to lose at least $8/share looking at post "agreement" market action.
To answer Toddster's question about "US taxpayers": The US taxpayers do not fund the Fed strictly speaking. But the Fed gets interest payments on the T-Bills it holds like anyone else who holds them, and the source of those payments is the US taxpayers. The Fed also gets money printed up at printing cost to "expand" or inflate the money supply. The electronic inflation is done in a variety of ways (e.g. lowering reserve requirements). That affects all dollar holders, not just US taxpayers. The actual "bill" from this debacle is still TBD, but it is a major departure from the past when junk debt was only collateral. Now it is owned by the Fed which means it was monetized which is also inflationary in the whole (inflated money being fungible).
I don't even think I've posted on this thread to this point, and I'm not going to do a forensic analysis because I don't put up with your crap any more. Here's the way your mind works:
1. You make up some BS (or just are wrong).This is an internet bulletin board. When someone accuses me of something I defend myself. When someone mischaracterizes my argument, as they do every day, I correct them. When someone attacks me I fight back. You need to MAN UP.
2. Someone asks you to elaborate, and you do not.
3. That person goes ahead and characterizes your argument the way he sees fit.
4. You complain that the characterization is a lie.
5. You are invited to explain yourself, and you do not.
As for you holding me in contempt? Who the eff cares? Your opinion is worthless to me.
I’m not making it up. I repeated what YOU said. You actually posed it as a question. So we all would like for you to expound on that claim. How do the taxpayers foot the 29 billion dollar tab?
So you pose a question with a false pre text and expect us all to agree? Or ignore it? Maybe you'd better stick to posting exact quotes from third parties.
It's an idiotic question. From an idiot.
For one thing, Cayne was forced to rescind his stock, all but $2/share worth. He was forced to lose at least $8/share looking at post "agreement" market action.
He sold it all at $10.84.
Now it is owned by the Fed which means it was monetized which is also inflationary in the whole (inflated money being fungible).
Only if they create new money to fund it, not if they use cash from maturing bonds or cash from bond sales to fund it.
This is the way you and your BUDDIES’ minds work:
You invent something out of thin air then attribute the statement to others.
When what is actually stated is reposted, you, and your buddies, continue to repeat your own invented statements made up out of whole cloth and continue to attribute them, not to yourselves...where it originated, but to others.
When you’re called on your fabrications.....you continue to deny you invented the statement and then, as you did on the last thread, say “you’ll get back to me” on it....but don’t.
When it repeats on yet another thread.....you deny you ever lied on previous threads.
For the record, the post to you in THIS thread NEVER stated you’d posted on THIS thread....it was a reminder to you of what one of your buddies does on threads to those who s/he disagrees with...because on a previous thread, which you were on, posting in a tag team fashion with one of your buddies, groanup did the same thing.
Your comment that "you're not making it up" is false. As I previously showed concerning the statement you invented, you did make it up. You claimed I stated the following:
groanup: The Fed buys bonds every time they want to boost the money supply. According to nic they get the money to do that out of the general tax fund. Right nic? I don't believe we ever heard your explanation about the mechanics of that.
You did NOT repost, then ask about, one of several rhetorical questions I posted....you lied about and fabricated a statement (the one above in red), and attributed that to me. You claim I said that in my post #12, which post actually states the following:
QUOTE:Therefore, you DID make up, out of whole cloth, the following: "The Fed buys bonds every time they want to boost the money supply. According to nic they get the money to do that out of the general tax fund. Right nic? I don't believe we ever heard your explanation about the mechanics of that.
Jamie Dimon, CEO of JPM, is a sitting director of the NY FED.
Question: Why did Bear Stearns' Chief Executive, Jimmy Cayne, get $50 million?
Grassely's interview with Kudlow last night. Grassely is the head of the Senate Finance Committee and will be grilling everyone involved in the JPM/BSC deal. MUST WATCH INTERVIEW.
http://www.cnbc.com/id/15840232?video=698522214&play=1
PAULSON DENIED ANY INVOLVEMENT IN THE DEAL!!!
PAULSON NEEDS TO TAKE AN OATH THAT HE HAD NO INVOLVEMENT.
Questions to be asked:
Why would anyone directly involved in the sub-prime fiasco at BSC get any compensation at all?
Why shouldn't they have to give back their compensation?
Why are they allowed to sell any stock at all?
Why shouldn't Bear Stearns' Chief Executive Jimmy Cayne be forced to rescind his stock to US taxpayers who will be footing $29 billion?
ENDQUOTE:
There is NO post, where I said that anything resembling anything like that.
There is NO POST where I ever spoke to the Fed buying bonds.
There is no post to where I ever stated that the Fed buys bonds to "boost the money supply."
There is NO post where I ever stated from where the Fed "gets the money to boost the supply of money."
And there is NO post where I ever made any statement concerning "the general tax fund."
Therefore, because the statement you concocted, and which you claim I said, is based upon words and content about which I NEVER made any actual statements, IT IS YOUR OWN WORDS and ideas.....not mine. If you were even able to find anything remotely close to my having said any such thing, on ANY THREAD, you and your tag team buddies would have been able to point to such a thing. But you are UNABLE to reprint where I said anything like it, because........it's they don't exist EXCEPT FOR YOUR OWN STATEMENT attributing them to me.
Rather than admit you've lied and lied repeatedly, or apologize........you continue to lie yet more. As I previously said, when you RUN OUT OF FACTS to discredit the truth, because you are no unable to have an honest debate, you resort to making up statements and pathologically lie, attributing your own words to others. You are, indeed, pathetic.
Hey dude, if it walks like a duck...
Yep.....you’re quite the liar.
After he agreed to sell at $2.
Only if they create new money to fund it, not if they use cash from maturing bonds or cash from bond sales to fund it.
The purchase of these junk securities makes it more likely that they will need to create new money to fund something else. The purchase of the securities is debt monetization which is inflationary. Mises will be proven correct when the dollar is ultimately destroyed but no doubt you will find some way in which he will be technically incorrect.
The officers agreed to sell the company at $2. The shareholders still haven't voted.
The purchase of these junk securities makes it more likely that they will need to create new money to fund something else.
Maybe.
The purchase of the securities is debt monetization which is inflationary.
Only if they use new money for the purchase.
He’s not an officer of the company?
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