Posted on 04/03/2008 9:22:59 AM PDT by TigerLikesRooster
April 3, 2008
Ben Bernanke admits Bear Stearns was hours from collapse
Dearbail Jordan
US Federal Reserve chairman, Ben Bernanke, today revealed that Bear Stearns was just one day away from going bust when the central bank stepped in to save the Wall Street bank to prevent chaos and a "severe" impact on confidence.
Speaking for a second day in front of US Congress, Mr Bernanke attempted to justify JP Morgan Chase's rescue of Bear Stearns, in a deal that included the US Fed agreeing to back $29 billion of the troubled investment bank's assets.
Mr Bernanke said: "... on March 13, Bear Stearns advised the Federal Reserve and other government agencies that its liquidity position had significantly deteriorated and that it would have to file for bankruptcy the next day unless alternative sources of funds became available."
The Fed chairman said that the central bank was forced to step in because the US financial system is "extremely complex and interconnected", and the collapse of Bear Stearns would have led to a "chaotic unwinding of positions in those markets are could have severely shaken confidence".
Mr Bernanke added: "Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain."
JP Morgan Chase agreed to acquire Bear Stearns for an initial $2 a share, valuing the lender at just $240 million. However, an investor outcry forced JP Morgan to increase the offer to $10 a share, as well as taking on $1 billion of Bear Stearns' assets with the remaining $29 billion backed by the US Fed.
Jamie Dimon, chief executive at JP Morgan, who was also appearing before Congress today, said the bank would not have offered to buy Bear Stearns if the Fed had not agreed to back the assets. His co-speaker, Alan Schwartz, chief executive at Bear Stearns, said today that the bank was not involved in negotiations between JP Morgan and the government regarding the $30 billion asset deal.
Mr Schwartz also maintained, as he said days before Bear Stearns nearly went bust last month, that the run that brought the lender to its knees was due to a lack of confidence and not because of a lack of capital or liquidity.
Mr Bernanke today reiterated his forecast that the US economy would slow in the first half before staging a recovery in the second half. However, like yesterday, Mr Bernanke refused to label the current economic situation as a recession.
It emerged today that US unemployment claims unexpectedly spiked last week by 38,000 to the highest rate since September 2005, alarming investors ahead of monthly jobless figures due out tomorrow.
New data revealed that the number of unemployment claims rose to 407,000 for the week ended March 29, above an expected 370,000 and the previous week's total of 369,000.
The sudden rise in benefit claims sent the Dow Jones industrial average down 48.6 points at 12,556.7 as investor grew nervous that today's figures are an indication of employment numbers that are due out tomorrow that are expected to show non-farm pay rolls for March have fallen by 60,000.
About half way down your link this interesting paragrapgh states:
One of the more curious exposures is gold derivatives. JPM has been the subject of considerable scrutiny by the Gold Anti-Trust Committee (GATA) as one of the chief culprits behind the alleged gold manipulation. JPM certainly does have large outstandings in gold derivatives. According to figures from OCC JPM had over US$ 41 billion of gold derivatives as at December 31, 2001. This represented almost 65% of all the gold derivatives held by US banks. It also represents the equivalent of 149 million ounces of gold assuming the closing price of gold on December 31, 2001 at US$ 279. Of course what we don’t know is the net exposure position as the figures are only the gross outstandings. And we don’t know whether their position is long or short gold and how it might relate to physical holdings. Still it did represent a drop of US$ 14.8 billion or 26.5% from the outstandings at the end of the second quarter. Quite a drop.
Do you know more about this? This was in 2002!
Carolyn
Then such derivitives trading should be outlawed.
Its not easy to understand as a layperson but the Fed action was not only necessary but it was fairly brilliantly executed.
(For those who want to return to the gold standard and want to argue about whether or not the Fed is constitutional or even really exists, please just continue on since I will only aggravate you.)
Bear Stearns collapse occurred in a matter of hours and not days. Bear Stearns assets were not the problem as much as Bear Stearns was a partner in subprime assets which had OTHER partners who wanted out. In order to prevent the liquidation of these assets, Bear either had to come up with the funds to buy out the departing clients OR get the best deal they could for the assets and then use their cash liquidity to cover the shortfall. This news gets around that some large hedge funds are dumping these subprime assets (no news yet on who first bailed and who then heard about it and then bailed, but that will be very, very interesting to learn). Bear didn’t have depositor clients bailing on them the first day. They had co-creditors who abrupted changed direction on them. They lost $20B in liquidity in about one day.
When news hit big players on the Street about this, they probably started spreading the news and within a matter of hours large accounts at Bear were demanding to be liquidated. Bear ran out of cash to cover these on Friday and that news caused even MORE account holders to demand to be liquidated. The Fed came onto the scene on Thursday when the first liquidity news came from the co-creditor problems. Bear announced to the Fed & SEC that they would have to consider Chap 11 to avoid collapse because their liquidity was depleted and they were starting to stack up requests of account holders to withdraw their funds (which meant liquidated a variety of positions for Bear now that their cash was used up.)
The Fed started looking into how to keep Bear alive until the weekend so they put out word to other large brokerages that Bear was in trouble and needed help (ie, fire sale notice). Had all this occurred on a Monday, Bear would have been in bankrupcty court and the market could have lost 1000 points and consumers watched half a trillion dollars in assets suddenly become valueless in the short term. Fortunately, the weekend came where nobody could act formally. And the Fed assign Bob Steele to work with the NY Fed Governor to arrange access for Bear to the discount window which is normally reserved only for depository banks like Chase, BofA or WAMU.
In order to secure the debt, Steele facilitated the essential takeover/sale of Bear by one of the other big five brokerages to ensure that the taxpayers funds would be managed correctly and repaid timely. It was clear that Bear wouldn’t last a full day on the open market that Monday so something had to happen before then. All of the other firms were able to make offers but JP was apparently best able and most willing to take on the discounted assets and assume the debt. And Jamie Dimon, the new head of JP, is considered almost universally to be incredibly sharp so the Fed, the SEC and Treasury blessed the lending of $29B to Bear if they agreed to a buyout by JP who would then back the funds for taxpayers.
There is an allegation in the WSJ that the Fed actually negotiated the price of the sale. But the Fed, NY Fed Gov and Treasury all deny this occurred (especially since that would be illegal). Whether they did or not, they pulled out some major league M&A within 72 hours and prevent a complete collapse of virtually every asset class that Bear was invested in.
To give a layperson an idea of what would happen if Bear collapsed (and this isn’t a complete list by any stretch so others like businessprofessor could add to the destruction), just think of all the companies, bank, commodies, mutual funds and indexes which Bear held in its $300B in holdings. If they needed to immediately sell the $400M they held in WalMart stock, for instance, the 80,000,000 shared they would need to dump on the market might push the price from $55 down to $30. If you, as an individual investor, owned WMT then you just lost nearly 50% of your stake. Instantly. And if you own a mutual fund or index fund, virtually every one in existence owns at large some WMT stock and those all take a hit.
And when Walmart (WMT) starts going down, hedge funds start pulling out of it as quickly as they start seeing the fall which pushes it down further. And trading desks have automatic trade software which triggers SELL orders as soon as a particular stock they own goes down by a certain percent within a specific amount of time (ie, 10% within 1 hour, which indicates panic selling) and those triggers push the stock price down further and faster which trigger even more people to want to get out before it hits $0.
And the equities are the ones which can take the beating easiest. Consider real estate holdings. You can’t liquidate a home in 24 hours, or even 30 days. So if you have $100M in home mortgages you need to liquidate you either have to find some other financial institution or private investment fund to buy your portfolio of loans. On short notice, you are looking at getting at little as $80M for those mortgages if they are all goldplated. So you just lost another $20M just to turn your loans into cash which is worse than the rate you get at a check cashing store or a loan shark. Even those machines at the supermarkets which count your change for you charge only 9%. And if your loans aren’t gold plated, well....
In the local real estate market where these homes exist, they now have a new owner who is a loan servicer and has no authority or interest in doing any renegotiating if you get into trouble as a homeowner. These loans are then more likely to go from delinquent into foreclosure. And that drives down the average home price in that neighborhood in the tens of percentages in comparable value (ie, your home just lost 10-30% in value when you need to appraise it for a loan or for sale).
Since the entire society is built on credit - the offering of for profit and the borrowing of money, when the assets which collateralize these loans or mortgages become far less valuable it creates essentially a more risky loan. And when existing loans are becoming risky, new loans either don’t get made or the newer loans get made at far higher interest rates or for far more onerous terms. Your mortgage offer gets uglier and your credit card interest rates go up.
So, in short, the Fed just saved your bacon. All of our bacon. And the arguments about Moral Hazard are nice as long as we agree that the collapse of the financial markets is not considered a good outcome just so we can all learn the right lessons from this. I can promise you that no financial firm in existence thinks that Bear Stearns dodged the bullet. Bear Stearns is dead. They were killed last weekend. They ARE the moral hazard for failing to securitize their assets safely. Nobody wants to become the next Bear just so they can get loans from the Fed.
Congress now has the responsibility (God help us) to decide whether the Fed should allow non-depository institutions access to the Fed window as a regular regulating function. I’ll not offer an opinion on that since I’ve said enough already.
Doing so now, with their use so extensive, would cause a worldwide economic disaster, and that is not an exaggeration.
Now would be a good time to try and find a way to restrain and limit their use in the future, but you can't just step in and outlaw their use all of a sudden.
Derivatives trading in itself isn't really a bad thing. Over exposure to derivatives trading is bad.
They reduce risk for one party by shifting that risk to another party. The problem is that these large investment houses have allowed too much risk to be shifted to them. If the market changes suddenly, companies that had seem solid suddenly see their assets go up in smoke.
The best site on the web for financial questions and especially definitions is www.investopedia.com. Just go to ‘Dictionary’ and put in any term regardless of how jargon-like it sounds.
My favorite right now is the 3-6-3 rule. Look it up.
Carolyn
Although the unpleasant truth in your scenario is that if a WMT can be taken down 50% by any concatenation of circumstances, it probably deserves to be, though that would require a frank acceptance of just how overpriced the markets have gotten and no one is willing to engage in that.
Carolyn
A derivative security is a security that “derives” from some other security.
To take an easy example a stock option is an option to buy (or sell) a particular stock at a particular price at a particular time. I would say that a stock option is a “derivative” as it derives from the stock which is another security.
In and of itself - derivatives are not intrinsically evil.
But as a practical matter, derivatives are often leveraged up the ying-yang. So for an intial investment of a few dollars you can potentially make (or lose) many times that. That’s where the real danger comes in.
Also as the derivatives themselves become more obscure in nature, they become more and more difficult to figure out what the heck they are actually worth at any given time. That creates all sorts of problems because a bank can say, hey we think they’re worth X so that’s how we’re valuing them on our books. And they have every incentive to paint a sunny day scenario.
ROFLMAO! If only!
In reality, the main use of derivatives is wild speculation in a super-high risk game of chasing super-high profits, while TELLING regulators and the dimmer-witted executives at the speculator's sponsoring financial institution that the trades are being done to "reduce risk".
You’re right.
Following that, the financial markets would have melted down. The credit markets would have frozen solid - for weeks.
The mark-to-market has to happen. The speed with which it has been happening already has caused severe credit market disruptions.
Forcing it yet faster would have finished vapor-locking the credit markets.
And then you would have seen the Fed do some even more extraordinary things.
Listening now to the testimony from CEO’s Bear Stearns and JP Morgan- idiot Senator Menendez asking DUMB questions...
Testimony on live- CNBC.
Some of these senators in these hearings are such IDIOTS..i.e. Chris Dodd.
They obviously have NO idea what they’re talking about.
Not to mention that "they" also have every incentive to structure derivatives to be as obscure and complicated as possible, since that makes it a whole lot easier to assign wildly inflated valuations to them, without anyone being able to specifically show why the valuation is wrong. It's not hard to value stock options or interest rate swaps on a day-to-day basis. And that's why those aren't the sort of derivatives that are causing the problems.
carolyn
That’s what you call proof ? You think a stock price justifies the Fed using taxpayer money to “encourage” one bank to loot another to save the pigmen of Wall Street is a good thing ?
No wonder no one cares about freedom anymore and the Republican party puts up John McCain - you all are so busy begging the Fed to bail out the perps of the scam you will accept chains for you, your children and your subsequent generations if pretty please, we can just have another up day on the DOW.
That’s just pathetic.
The only thing that will restore this world to financial sanity is if all the “mark to fantasy” notes are instead “marked to market”.
Will we all hurt ? Yes, but it’ll be a lot worse if we don’t- The pigmen will keep their billions and the middle class will cease to exist.
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