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.
That question* to Sec. Paulson you posted implies that taxpayers are bailing out Bear Stearns. A number of people pointed out to you that this is not a taxpayer bailout. I know little about the deal itself. Assuming that it is not a taxpayer bailout, you were:
1. posting something with which you disagree, orBy the mechanics of posting on threads in general, words become "your" words the second you post them. It's as if you have a proprietary interest in them . . . you can't weasel your way out of them by saying they're someone else's. You posted them. (And you didn't post them to disagree with them, get it?)
2. throwing "stuff" at the wall to see what sticks, or
3. trying to demagogue the issue. (2 and 3 are related)
It's really not that complicated. You see it all the time, people saying "oh, I just threw that out there," or "I didn't know that wasn't true." Everyone just moves forward after that . . . but you don't. I really don't understand why you expect to post crap with impunity and then avoid defending it. It's as if you demand the freedom to post anything you wish, and simultaneously you insist people are not free to post anything they want in response.
Trying to explain this to you is a chore. Suffice it to say, you cannot post crap without expecting people to ask why are you posting crap. And if you do not explain why, expect people to make fun of it, and you.
_____
*"Why shouldn't Bear Stearns' Chief Executive Jimmy Cayne be forced to rescind his stock to US taxpayers who will be footing $29 billion?"
It was claimed that 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.But I did not; do you get that? Those were groanup's own words, do you get that?
He did NOT repost, then ask about, one of several rhetorical questions I posted....he lied about and fabricated a statement (the one above in red), and attributed that to me. Claiming that I stated those words in my post #12 doesn't make it factual or true. My post in #12 actually stated the following:
QUOTE:Therefore, what is CLAIMED that I said WAS, in fact, MADE UP, out of whole cloth, as follows (once again): "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:
To repeat:
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, the statement attributed to me was concocted, was and is based upon words and content about which I NEVER made any actual statements, IT IS NOT MINE OWN WORDS and ideas.....BUT OTHERS. It's really not that complicated. I see it all the time, YOU PEOPLE misrepresenting what your opponents state and then continue to deny that they were your own inventions.....you are unable to say "I ADMIT I LIED" or "I THOUGHT THAT'S WHAT YOU MEANT...MY MISTAKE." And if you would, yes, then EVERYONE COULD "just moves forward after that" . . . but you don't." I really don't understand why YOU expect to be able to post LIES with impunity and then CONTINUE reposting it and defending those lies and your buddies who lie. It's as if you demand the freedom to post anything you wish, and simultaneously you insist that people are free to post all the LIES they want in response.
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, the statement attributed to me was concocted, was and is based upon words and content about which I NEVER made any actual statements, IT IS NOT MINE OWN WORDS and ideas.....BUT OTHERS. It’s really not that complicated.
Face it, you post crap.
There is NO post, where I said anything resembling anything like, "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," AS YOUR BUDDY CLAIMED.
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.”
Face it.....he LIED and you're defending him for doing so.
I’m growing weary of you. Why don’t you run back to DU and find someone to hold your hand?
Same response you had last time caught in the obvious lies.
No apologies. Just further insulting comments.
It is you and your buddies who should go to DU....where they have no ethical standards either....just a den of liars and thieves.
Oh yes you did. You called it a taxpayer bailout. If the BSC deal was a taxpayer bailout you never explained how. One can only surmise from your tacit assumption that you must think all Fed actions are paid for by the taxpayer.
I can't wait until the Fed drains money so we'll get some back. LOL.
Once again, how are the taxpayers footing the 29 billion?
There is NO post, where I said anything resembling anything like, “The Fed buys bonds every time they want to boost the money supply.” Nor, did I ever say “they get the money to do that out of the general tax fund,” AS YOU CLAIMED.
I NEVER spoke to the Fed buying bonds.
I NEVER stated that the Fed buys bonds to “boost the money supply.”
I NEVER stated from where the Fed “gets the money to boost the supply of money.”
I NEVER made any statement concerning “the general tax fund.”
And I NEVER stated that “the Fed gets the money to increase its supply of money from the general tax fund.”
You made each one of those statements up, and attributed them to me. You LIED.
Is the Bear Stearns deal paid for by taxpayers? Yes or no?
Maybe you could explain how the Fed boosts the money supply?
Never mind. I'm kidding. Don't strain that tiny brain.
What’s the difference between saying the taxpayers are paying for the BSC deal and the taxpayers are paying for the FOMC operations? I’ll tell you the difference - nothing.
Either Sarbanes Oxley is worthless law or some folks from Bear Stearns should be headed for court. No?
Sarbanes-Oxley isn’t worthless law. It’s great for using our own American based companies to build infrastructure abroad so they can relocate their headquarters.
Agreed, but didn’t Bear Stearns” CEO violate it when he said they had ample cash on hand two days prior to their collapse?
OMG! The Treasury doesn't give money to the Fed. The Fed actually gives money to the Treasury. Congratulations.
Do you realize what that means?
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