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.
Ping!
Agree. If we learned one thing from the 1929-1932 period, it is that if the Fed has ANY job at all, it is to keep banks from failing and preventing contagion.
Bernanke's days at the Fed may be numbered.
CNBC is showing him at Congress now. It’s turned pretty much into kabuki theater: somebody asks him how something like this could have happened so quickly, how can any one of many companies be sufficient to collapse the nation’s financial system, and he just stumbles out a meandering response (not an answer) that invariably includes all the phrases “long time in the making”, “international repercussions”, “interconnected” (the new way of saying “too big to fail”), the senator thanks him for his answer, and then the next senator takes his turn on the dance floor.
So he basically admitted that JPM was the next domino to fall if Bear had declared bankruptcy. And JPM has, nominally, 24T dollars worth of derivatives at stake, of which Bear was the counterparty.
http://www.gold-eagle.com/editorials_02/chapmand061302.html
This is a story that bears repeating. J. P. Morgan Chase & Co. (JPM-NYSE) is one of the biggest banks in the world with assets of approaching US$ 700 billion, capital of about US$ 41 billion and a market cap of US$ 71 billion. By comparison Canada’s largest bank the Royal Bank of Canada (RY-TSE, NYSE has assets of about US$ 235 billion, equity of about US$ 12 billion and a market cap of about US$ 26 billion. J.P. Morgan Chase is roughly three times the size of Canada’s largest bank.
But there is an area where J.P. Morgan Chase dwarfs the Royal Bank. Indeed J.P. Morgan Chase dwarfs everyone in this business. The business is derivatives. In the USA J. P. Morgan Chase is over 50% of the derivatives market. According to figures from the Office of the Comptroller of the Currency (OCC) as at December 31, 2001 JPM had notional amounts of derivative contracts outstanding of US$ 23,520 billion or US$ 23.5 trillion. That was out of total derivatives of reporting banks of US$ 45.4 trillion. The aforementioned Royal Bank of Canada had at the end of their second quarter a notional amount outstanding of approximately US$ 1.2 trillion.
Ah the old "second half recovery" routine. Gawd how many times did we hear that from the tech companies in the first two quarterly reports of 2000 and 2001.
It’s pretty simple how one bank could lead to many other failures, at least in this country. The nanny-state education has set in and some people don’t know how to use the john without government intervention. Had the government allowed such a company to collapse under the weight of its own mismanagement, people would have panicked and done even more damage.
Apparently the lack of confidence started at the top. I've seen reports that Bear-Stearns execs sold 27 million shares of B-S stock for $2 billion in mid-February.
If Bear-Stearns did not have a lack of capital or liquidity, why hasn't any other outfit offered more than $10 per share for it?
The market after digesting all the public information available on BSC valued it at $30. All the available public information was a lie. It was worth less than nothing. How can anyone have any confidence in this stock market?
However, the prices would be public and therefore, *every other holder of this exotic paper* would have to assign a value to what they were holding. And then bump up their reserves to cover it.
Because massive and largely pointless regulatory burdens have forced the consolidation of certain types of financial business into a few huge institutions, so that they can manage the regulatory burden through economies of scale.
Re: Ben Bernanke admits Bear Stearns was hours from collapse
This made as much sense as bailing out Pets.com would have in 2000.
If a few people can take down the entire economic world, then perhaps derivitives trading should be more closely regulated, or done away with entirely.
We didn’t have it in the 1950’s and somehow we managed to thrive and prosper!
Indeed. The proof that the Fed did the right thing here is that of all the parties whining about how it was the wrong thing, not one is offering a higher bid to accompany the whine. Even while it was still at $2/share, there were no other bidders.
You’re not supposed to see the men behind the curtain.
Pay no attention to them.
Indeed. If more proof is needed one only needs to listen to the Sr. Senator from NY (who's name I will not repeat).
I will also add that I think he posts here.
An extremely astute observation.
About half way down your link this interesting paragrapgh states:
One of the more curious exposures is gold derivatives. JPM has been the subject of considerable scrutiny by the Gold Anti-Trust Committee (GATA) as one of the chief culprits behind the alleged gold manipulation. JPM certainly does have large outstandings in gold derivatives. According to figures from OCC JPM had over US$ 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.
http://www.fgmr.com/morgan-enron.htm
Read this - you will find it interesting.
All the more reason the bailouts and obfuscations papered over by the SEC and the Fed need to stop.
So you vote for fascism, cronyism, and bailouts by taxpayer dollars ?
We deserve what we get - it’s no wonder our leaders are so corrupt. All the people want is to be given a lollipop and a pat on the head before going back to sleep to get fleeced by the “elite”.
Marking to market would cause a TU condition in the financial markets and bankrupt governments of any overleveraged parties, but we'd all come out better and more honest on the other side.
The Fed acted to save all the ordinary people whose finances would have been decimated by this. The Fed didn’t give a crap which big financial institution got a windfall, but they only had one choice because only one institution was willing to commit to a deal on such short notice. This was an emergency caused by Bear Stearns, which for all practical purposes no longer exists (i.e. the guilty reaped what they sowed).
JP Morgan will probably end up with a nice fat profit on this, but nowhere near the amount that the individual taxpayers would have lost had the deal not been done. The Fed may well not end up spending a penny of taxpayer money on the deal — they gave a guarantee to pay IF Bear and its counterparties end up unable to pay. But even if the Fed ends up having to pay out the whole $29 billion of the guarantee, that’s a drop in the bucket compared to the hit that ordinary taxpayers would have taken without this deal.
To use a simplified scenario, the Fed was faced with a choice of 1) promising to tax you an extra $100 dollars IF the guarantee ever needed to be paid, in order to get the JPM deal done, or 2) sitting back and watching the global financial system undergo a total collapse, which would cause the value of your house to drop by about 50%, the value of your retirement savings to drop at least that much, and the unemployment rate to skyrocket, possibly costing you your job. Would you really have preferred that they choose option 2?
Agreed. I found this following quote from JPM most interesting:
“We don’t have any real exposure to gold.” Perhaps in your investigation you can ask him to define the term “real”.
Without transparency, the fat cats can pull some amazing stuff and leave the rest of us holding the bag.
If the "value" of our investments can be wiped out that easily, then it is not a real valuation. It is a fantasy and will find it's true valuation in short order. You think there aren't many more Bear Stearns out there that just have not come to terms with reality yet? You think the mortgage crisis is over? How can the global economy be so robust and strong and yet so fragile at the same time?
It can't. It is an illusion. It is just a matter of time.
I have a close friend who is in bankruptcy right now.
The reason that the pain of bankruptcy is limited, is because the government steps in and keeps you from getting completely crushed by the effects of your own mistakes.
That's what the government was trying to do by backing some of Bear Sterns assets, but they weren't really doing it for Bear Stearns. They were doing it because they were worried about a complete collapse by Bear Sterns might cause people to pull their money out of investment banks on a huge scale. Not just Bear Sterns, but all investment banks.
If there's a run on banks, we end up with another great depression. The Fed is trying to instead soften the blow caused by people's overzealous risk taking, and tone down the effects to stagnation or a short recession, rather than a repeat of the great depression.
What the fed is doing kind of resembles how the government protects you during bankruptcy.
You are obviously not a student of any past depression. You also missed some testimony. JPM was the ONLY bank offered the opportunity to buy BSC. Wonder why, or you don’t care ? Did you know that Jamie Dimon is a governor of the NY Fed ? Do you know who he is ? Did you think to ask what side of the table he sat on during the “negotiations” ?
Even that idiot Dodd got it right - What the Fed is doing is privatizing the profits, socializing the losses. We are living under a fascist economy, and it won’t change when the next administration takes office. Both the Republicans and the Dems are in it up to their eyeballs.
And yes, option 2 is far preferable IF it means we can finally get the transparency that is so necessary in our financial system. Don’t you care about life, liberty and the pursuit of happiness ? Or are you more interested in your comfortable existence where you eat your hamburger every nite and fall asleep to American Idol ? As the Founders said, if we trade freedom for security, we are lost. Your post is proof of that mentality - just let the Fed hide the bad stuff so you don’t have to bother your pretty little head over it.
And finally, the average American’s retirement and everything else they hold as an asset is already under assault. Inflation is heating up in the energy and commodity sectors, house prices are dropping like crazy, and the demographics of the boomers will ensure the market doesn’t recover in the next 10 years or more, unless you favor a greatly inflated immigration in years to come. You can’t trade the market because it is so manipulated by the Fed and other major institutional insiders that it has become quite irrational. Explain Tuesday’s 400 pt rally. What fundamentals or news showed up on Monday or Tuesday to justify such a thing ? Social Security and Medicare are a joke, especially after this year when every one of the Presidential candidates favors amnesty and giving SS and Medicare to the illegals.
No, unless we get back to no corporate welfare, allow those highly leveraged individuals and institutions to fail and take their losses, and start promoting honesty and ethical action, there is no USA. We are no better than the USSR. Welcome to socialism, comrade.
My house has already dropped maybe 10%, my retirement is as secure as I can make it because I’ve paid attention to the economy, I have no debt because I don’t live above my means, and I know we would suffer short term pain but long term we wold be so much better off.
Short term pain, long term gain. Instead, just like Japan we’ll have short term “stability” with maximum long term pain.
Knowing JPM what they probably meant was they were both long and short gold.
The “elite” are rearranging the deck chairs for their comfort while j6p has a very uncomfortable time in steerage, but I believe in the end we are all in the dumper unless transparency, honesty and ethics once again are a hallmark of our government and economy.
Amazingly enough, we survived the depression, and many people came out a lot stronger. Debt was minimal, people learned what was important, and they all learned that actions had consequences.
Instead, the nanny state has decreed that the very people responsible for the mess, who are the Fed, the IBs, the commercial banks, the monolines, the ratings agencies, and the government oversight agencies, will be bailed out by joe taxpayer. The bank execs are still pulling down their multimillion $$$ salaries but joe taxpayer sees a huge increase in daily expenses and joe taxpayers children and grandchildren will live in a country that will either 1) be so underwater in debt that we inflate our way out of it or 2) we default on our debt and we become just another failed state with citizens paying the price in prosperity.
You miss the entire point. If failure is not an option, then no consequences occur and no lessons are learned. Has JPM accepted any further regulations to the effect of unwinding their derivatives positions, deleveraging, bringing crap back on their balance sheets, running a transparent business so their shareholders don’t wind up paying for management mistakes ?
No. There were no consequences to anyone other than BSC shareholders and lower-level employees. Did these people deserve to pay, or should the a$$hats in management who approved the overleveraging been the ones to pay ?
Welcome to the nanny state, where people making 7,8,9 and 10 figure salaries and bonuses are considered worthy of bailouts. God, this stuff makes me sick.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.