Posted on 04/09/2008 6:50:07 AM PDT by Toddsterpatriot
"Oh, no! Two dollars!"
So cried investors three weeks ago. The Federal Reserve had just announced that it was lowering the discount rate by a quarter of a point and had arranged for the sale of Bear Stearns to JPMorgan Chase. Stock futures jumped on news of the discount rate cut and Bear sale until investors heard the price.
The market's anxiety was justified. If a legendary Wall Street investment bank that investors valued at over $100 per share just last December was suddenly worth next to nothing, what were the other Wall Street firms, such as Goldman Sachs, Merrill, and particularly, Lehman Brothers really worth? The news sent S&P 500 futures spiraling and set the stage for a tumultuous opening that Monday morning.
Recap on Crisis
Bear Stearns, founded in 1923, has been an aggressive player in the financial markets for many years. One of the pioneers of mortgage-backed securities in the 1980s, Bear was heavily involved in the packaging of sub-prime mortgages during the housing boom. As the prices of these securities slipped last year, Bear bought not only for its own account but also for its hedge funds that it established for its wealthy investors. Bear's purchases were financed with short-term borrowings that were collateralized against these securities. But as the market continued to tumble, lenders demanded more cash to secure their loans. When Bear knew it would not have enough cash to cover the margin, it went to JPMorgan, one of its lenders. Both then turned to the Fed to arrange a $30 billion dollar loan guarantee against Bear's assets to prevent the firm from going bankrupt.
When the Fed guarantee was announced on Friday morning, March 14, Bear stock plunged $27 a share to close at $30, which was what traders thought the company was worth at week's end. That is why the $2 price announced Sunday was such shocker. If Bear management was willing to sell at $2 and there were no other offers (a few hedge funds attended the weekend meetings but declined to bid), investors wondered what the other giant Wall Street investment banks were worth.
A Bailout?
Was the Fed's loan a bailout of a Wall Street firm that had made risky bets and deserved to go under? And how much is the taxpayer going to lose as a result of the Fed deal? Both Barack Obama and Hillary Clinton, contenders for the Democratic presidential nomination, blasted the Fed's action as bailing out Wall Street firms while letting "Main Street" homeowners with mortgages wither on the vine.
The Fed loan probably did prevent Bear from going into insolvency, but it hardly "bailed out" investors. Bear sold for $172 a share last year, once valuing the firm at over $20 billion. The Fed agreed-on price on March 16 was $2, about $250 million, which represents a 98.4% wipeout for investors. Furthermore, Bear as a firm is gone, its assets absorbed by JPMorgan, who will no doubt dismiss a large chunk of its nearly 16,000 employees. And, as I note below, the higher price agreed to a week later actually reduced the Fed's exposure to Bear's troubled assets.
The Details
Here are the details of how the Fed loan will work. The Fed has agreed to effectively lend $29 billion against a portfolio of mostly sub-prime securities that Bear Stearns "marked to market" on March 14. It is important to recognize that this sum does not represent the face value of these securities, which is far higher than $29 billion, but the extremely depressed market prices brought on by the current crisis. JPMorgan, which oversaw the valuation of these securities and also assumed some of the risk, claimed that they were satisfied with the prices that Bear determined.
The higher $10 price that was agreed on a week later required JPMorgan to take a loan against the first $1 billion to Bear's securities, lowering the Fed's guarantee to $29 billion. Given the 120 million shares of Bear Stearns outstanding, the reduction in the Fed's contribution is approximately equal to the $8 increase in the price Bear stockholders will receive.
The $30 billion in assets will be deposited in a newly-created corporation established for the purpose of administrating and selling these securities. The Fed will earn an interest on its portfolio at its ongoing discount rate (currently 2.50%, 25 basis points above the targeted Fed funds rate), and JPMorgan will receive a higher interest rate of the discount rate plus 450 basis points, (currently 7%) on its $1 billion loan.
All proceeds from the sale of Bear's assets will first go to repay the full $29 billion principal and interest due to the New York Fed. Only when all interest and principal is fully paid to the Fed will any further proceeds go to satisfy the $1 billion in subordinated notes due to JPMorgan Chase. Once JPMorgan's note is satisfied, any further proceeds will go entirely to the Fed. In short, unless the default levels soar above the level now anticipated, the Fed will likely recover the entire proceeds of its loan and more.
You may ask if Bear's securities were such a good deal, why didn't the private sector make a bid for the investment bank? Well, $30 billion would be a big chunk for any institution to swallow, and even if a consortium could be established to raise the money, the speed at which Bear's position was deteriorating argued for a rapid merger since no other lender was ready to step forward.
It is my opinion that not only will the Fed get its money back plus interest, but will make a tidy profit on the transaction. As bad as the housing market is, many of these securities are being quoted at prices below most worst-case scenarios. Two years ago, any security that was "asset backed" - and particularly "real estate backed" - was considered golden and priced with almost no risk.
Today any security with the words "real estate" attached is consider toxic and priced at extreme risk. The reality, as usual, is somewhere in between. The Fed did not bail out Bear at taxpayer expense, but enabled - as it is mandated - the financial markets to continue to function. History will call the Fed's action the right move at the right time.
Ping!
Cue the “Aw Jeez” guy. :)
Thanks for posting this.
So we’re still all gonna die, right?
5....4....3....2....1
I read here on FR that JPM got $30 billion in free money hot off the Federal Reserve’s printing presses. Who to believe?
This is true because of the fact that any time a private entity needs a government loan guarantee, it means it cannot get a loan from the private sector. Of course, the main reason for a private entity not being able to get a loan in the private sector is because the private sector doesn't believe the entity is capable of paying back the loan (in a perfect world, at least).
Bear Stearns should have been allowed to collapse. The short-term economic pain would have been far less than the long-term economic pain we will now be enduring because we've decided to take the Soviet approach to bailing out failing companies.
You simply have no idea what you’re talking about. Had BS been allowed to collapse, there would have been a massive and hysteric “run on the banks” (and all other investment houses) that could have easily thrown the world into a depression. The “Fed” is in place to make sure these things don’t happen. BS has failed...shareholders have lost money....management has been fired.....but the good news is that the “economic wheels” of the Country and World are still on the bus.
Who has a loan guarantee?
we've decided to take the Soviet approach to bailing out failing companies.
Let me know when the Bear Stearns employees start cashing pay checks from the government.
So what should we do then? Reward every single private entity that makes bad investment choices with a bailout? What about the rest of us who made more responsible investment choices? Why are we on the hook for those who did not do that?
How was Bear Stearns rewarded? Or Countrywide? Or New Century Finance?
Why are we on the hook for those who did not do that?
How are you on the hook?
How were they rewarded? Bear Stearns as a company will soon be gone, the shareholders got pennies on the dollar for their stock, and many of the employees will lose their jobs. That is not a reward. That’s a company that made bad decisions ceasing to exist.
Bear Stearns was not bailed out; the financial system was.
So basically our economic policy should be "let's practice capitalism, until someone screws up, and then we get the government involved." All this sort of thing does is create more reasons for the government to bail out other bad investors. We already have talk of bailing out the banks that chose to lend money to people they knew would not pay it back. Why stop there? Let's just have a command economy and be done with it.
FTFA: Both then turned to the Fed to arrange a $30 billion dollar loan guarantee against Bear's assets to prevent the firm from going bankrupt.
Bear Stearns and the other firms involved were rewarded by being able to get loan guarantees that ordinary people could not get had they made the same bad financial decisions.
How are you on the hook?
Who pays the taxes that will be used to cover these loans should they fail to be repaid?
It’s a semantic quibble. They bailed out the bond-holders, not the shareholders.
“Any government loan guarantee is a bailout.”
Not necessarily. JP Morgan has to pay back the loan from the gov’t, don’t they? I did not read that they were off the hook in re-paying this loan. It sounds similar to when the gov’t gave loan guarantees to Chrysler (20 yrs ago maybe) - Chrysler paid it back and successfully moved forward.
I agree with the Fed’s response- a “run” on the investment banks would have been much worse.
I think guarantee is not the best word to use. They were going to pledge collateral and receive a loan.
Who pays the taxes that will be used to cover these loans should they fail to be repaid?
The loan is not funded with tax dollars.
That’s not what I said at all. There is a reason banks and investment companies are so highly regulated. Its because they are key to our financial system. Would you be willing to suffer through a prolonged depression to avoid having the Fed getting involved in a failing institution?
No, but the the major players have become quasi-governmental entities - allowing Bear Stearns to fail would have killed too many innocent bystanders. Yes, to an extent they have been indemnified against the consequences of their poor decisions - but not indemnifying them would have done to much damage to the US financial system.
It's like the fire department putting out the fire in an apartment unit containing a meth lab to save the rest of the building - you can argue that the fire department should have minded their own business because the meth cook deserved to have all of his stuff burn up, but that's cold comfort to the other residents. ;)
The bond holders are not Bear Stearns. If the firm was liquidated the bond holders wouldn't have received their money back? How do you know?
If they are so highly regulated, how did we get to the point where BS was on the verge of bringing down the entire financial system?
Nonsense. The Fed has begun a new chapter: this was not a loan, this was not a "liquidity injection", this was a direct investment in J.P. Morgan. The Fed is now directly investing in U.S. financial firms.
How do you figure that?
The Fed bought shares in JP Morgan? How many?
We can ignore the legal shell game of the “newly-created corporation”, if that’s your angle.
Toddster! It’s me! Jiggyboy! Not some newbie who hasn’t yet figured out your debate-club tricks!
We all know I’ve called you out on your semantic and legalistic quibbling so many times I’ve gone hoarse.
Post of the day, IMHO! I'd much rather see our news organizations spend time on this, rather than Hillary ducking sniper fire.
I don’t want to ignore anything and I don’t have an angle. I want to know the answer to what I asked.
Oh goody!
Not some newbie who hasn’t yet figured out your debate-club tricks!
Great.
We all know I’ve called you out on your semantic and legalistic quibbling so many times I’ve gone hoarse.
Then it should be easy for you to explain how the Fed made a "direct investment in J.P. Morgan"
Unless you're too hoarse?
My turn to just ask questions: Was this a loan?
My turn to just ask questions: Was this a loan?
JP Morgan.
If the securities are worth less than the $29 billion the Fed has guaranteed, the Fed takes the hit.
Then to who was the loan made, and, if said borrower doesn’t pay it back, who’s out 29 gigabucks?
Bear Stearns is going away. Investors, officers and employees are taking huge losses. Many employees will lose their jobs.
But if you can make money from the government jumping in here and there, that's fine and dandy. lol
I didn't own any shares of Bear Stearns. I didn't make any money when it went from $54 to $30 on Friday, March 14th. I didn't make any money when the announcement came out on Sunday, March 16th. I didn't make any money on Monday, March 17th when it dropped to $3. I didn't make any money when JPM raised their offer to $10.
JP Morgan.
The Fed isn't loaning any money to JP Morgan.
If the securities are worth less than the $29 billion the Fed has guaranteed, the Fed takes the hit.
If the securities are sold for less than $29 billion the Fed will absolutely take a hit.
Yes. But not to Bear Stearns and not to JP Morgan.
What kind of loan gives the lender a cut of the profits in addition to the interest payments? Is there any other entity making that kind of loan? When I get my next mortgage, I want to make sure it's not that kind of loan -- what's the term for that feature of the loan?
A new entity which will hold $30 billion of securities.
and, if said borrower doesn’t pay it back, who’s out 29 gigabucks?
The New York Fed.
They'll probably prevent some issues and make other problems worse.
What do you think about Sarbanes-Oxley?
And we are setting a precedent here for corporations to make poor business decisions without worry because they know the government will give them corporate welfare or a safety net
Countrywide and New Century Finance made poor decisions. I don't remember the government doing anything to help them.
Ummm, yes, they are. The securities are collateral for the loan. It's off-balance sheet for JP Morgan, just as SIVs were off-balance sheet for banks, but the ultimate beneficiary of the loan is JP Morgan.
Ummm, no, they aren't.
The securities are collateral for the loan.
You bet. $30 billion of securities that belonged to Bear will be collateral.
It's off-balance sheet for JP Morgan,
Why would securities not owned by JPM and money not loaned to JPM be on JPM's balance sheet?
Big deal. $30 billion taxpayer’s money is put at risk to bail out these guys. They Bear Stearns stockholders were sacraficed so that the securities could be propped up? Who holds those securities? Well JP Morgan for one. And who was voting to approve this deal? The New York Fed. One of whose 9 voting governors is Jamie Dimion, Chairman of JP Morgan. Also Richard Fuld, Chairman of Lehman Brothers, the firm considered most exposed after Bear. While we are at it we should also consider Jeffrey Immelt, CEO of GE, which has a huge investment banking business.
The deal was approved (that is the person who signed off on the taxpayer risk) is Sec. of the Treasury Paulson, who is a former head of Goldman Sachs.
If you don’t see the huge, gigantic conflict of interest in this deal I feel sorry for you. The author is just another apologist trying to make us feel better about being screwed over by the Fed.
This bailout is only the most visible of the many steps the Fed has taken in the last three weeks to shore up these banks. All of them are a big part of the reason that one US Dollar is worth on Swiss Franc today, not two or three as in the past.
Borrow money at 3% and lend it back to the stiffs at 20%. (or more!). Yes, that is a government license to steal, and the folks at the top are making good use of it.
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