This is a VERY creative and interesting transaction bump.
Definitely worth a look - it got a wee bit technical at times, but was also straightforward enough for you to get a whiff. Fascinating.
Thanks for posting.
D
“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?”
I think the Fed’s participation will have ORDINARY consequences.
1: The dollar will continue to deteriorate in terms of purchasing power.
2: Money center banks will be rewarded for their profligacy and recklessness and will be given an essentially unregulated monopoly franchise into a reformulated financing and equity-issuance regime whose minutiae can only be guessed at from where we sit today.
3: (related to #1) The most responsible savers and homeowners will be severely punished by the market-wide deterioration in the valuations of their homes; the loss in interest-earning capacity on their savings, and the inevitable increase in their property taxes as counties and municipalities seek to make up for the losses in property tax receipts and the loss in purchasing power thereof.
It is not a loan at all. The Fed and J.P. Morgan are creating an investment fund, to be managed by BlackRock
...The Fed's ownership stake will be $29 billion, ostensibly in the form of loans at "the primary credit rate, which currently is 2.5 percent and fluctuates with the discount rate". But, that is largely meaningless. If the investment company's assets turn out to be worth less than the principal and interest due the Fed, then the Fed's loan won't be repaid. If its assets appreciate, J.P. Morgan gets paid out, and the rest belongs to the Fed. The only significance of the "interest rate" would be if, as the fund unwinds, asset values are high enough to make only a partial payment to J.P. Morgan. In this case, the interest rate would help determine the split between the Fed and JPM.Essentially, the Fed will own this investment fund and the Bear portfolio outright. JPM's position is basically a call option on the fund's assets at $29B plus time-value whose value is capped at $1B plus time-value. (JPM is long a call option and short the same option at a higher strike price.) The Fed can deny all it wants that it is considering purchasing mortgage-backed securities. That is the economic effect of this arrangement. The Fed is buying up mortgage-backed securities and other unspecified assets at "the value of the portfolio as marked to market by Bear Stearns on March 14, 2008."
But we already knew that.
...in precisely what sort of assets besides mortgage-backed securities [will] this fund hold. I think that MacroMan used the term "SIV" advisedly. The signal fact about SIVs is that, though they were formally off-balance sheet, limited-liability entities, in reality SIV sponsors bore downside risk beyond their legal obligations to the funds. Reputationally, the banks who sponsored these "independent" entities could not just let them fail.
I have a simple question, one to which I think taxpayers deserve a simple answer. Will this new "limited liability company" have contingent liabilities to any parties other than the Fed, J.P. Morgan, and BlackRock for ordinary management fees? Will its portfolio consist of any positions that would make the fund a counterparty, potentially with obligations to pay, not merely rights to receive, future cash?
If the answer is no, a plain statement of that would be nice. If the answer is yes, then don't count on the "limited liability" of this investment company to provide taxpayers much protection. It's strikes me as implausible that a fund backed by the Fed would default on obligations to third parties. We've had central banks touted as lenders of last resort, market-makers of last resort, and fools of last resort. We'd better think very carefully before letting the Fed become a derivatives counterparty of last resort. The very idea represents a subsidy to those we may not wish to subsidize. There's never been such a thing as a risk-free derivatives counterparty. Every holder of a derivatives position has an implicit option to declare bankruptcy and not pay should circumstances move decisively against them. Parties who retain an option to default while the other side of the contract is taken by someone who cannot are gaining something of value, something I'm not sure we want to give. Should counterparty risk move from a theoretical bogeyman to an actual crisis, the scale of sums at risk could be large, even on a portfolio whose current net value is only a few billion dollars, as those owing the Fed refuse to pay while Fed is obliged to cover "offsetting" positions from the public purse.
What happened to the “little guy bailing out the fatcat” meme?
Are their documents that must be publicly filed for this LLC, the way that e.g. corporations must make a filing to the state gov’t they are incorporated in? Would be interesting to see that filing.
btttt
Great article. Thanks.
Either Sarbanes Oxley is worthless law or some folks from Bear Stearns should be headed for court. No?
Bookmark for reading in 2036.
Questions for Paul O'Neill
March 30, 2008
Q: Do you feel bitter about your service for the Bush administration?
A: No. I’m thankful I got fired when I did, so that I didn’t
have to be associated with what they subsequently did.
Q: Do you think it was appropriate for the Federal Reserve
to lend a helping hand to Bear Stearns and save a private
investment company from its own bad decisions?
A: I would say they didn’t save Bear Stearns. They saved
the financial system from a panic collapse. I reject the
notion that they helped Bear Stearns. Bear Stearns was
destroyed.