We haven't heard the last of the Bear Stearns bailout-buyout plan orchestrated by the Federal Reserve and the Treasury Department. Now that the markets have started to recover from the initial shock over this unprecedented action, the political class is starting the raise the all important questions about who benefits from the deal and who pays. As is always the case when political institutions are involved, the two categories have only an incidental overlap. As time goes by, there will be more and more second thoughts.
Over at National Review, David Freddoso introduces us to a Republican Congressman who wonders what happened to his party's commitment to free markets. Are there no free-marketeers in financial foxholes? His summary of the way the Bear Stearns deal looks paints a very ugly picture.
In short, this is the mother of all government subsidies — a non-legislative appropriation that doubles the size of all this year’s congressional pork projects combined. Without so much as a vote of Congress, taxpayers are to buy securities of undetermined value for $29 billion — roughly Panama’s GDP, or the Federal Reserve Bank’s entire annual profit. They take this enormous risk so that JPM, a company worth $146 billion, has enough liquidity to make a major and profitable acquisition for next to nothing. JPM is more than happy to take on Bear’s book of client and counterparty accounts — these were probably never in danger of being lost, and it’s great business for JPM. The ones being rescued are Bear’s bond-holders. They keep their shirts. The stockholders at least keep their socks. The profits from the good times are retained, and the losses are socialized.
Bear with Me [National Review]
Posted by NomadTrader , Apr 02, 2008 10:22AM
DF hits the nail on the head - "profits ... are retained, and the losses are socialized."
Welcome to the new Wall Street paradigm.
Posted by guest , Apr 02, 2008 10:27AM
Does anyone else think that this socialization of losses is a horrible path for the Fed to take? I can't pin down the exact repercussions of this in the future, but the ethical boundaries that the Fed is crossing makes me nervous.
Posted by guest , Apr 02, 2008 10:29AM
Is the recession a myth?
- Guess which subgenius television network had that in their promo this morning.
Posted by guest , Apr 02, 2008 10:31AM
@10:27 Ethics and Wall Street? Since when? Ethics and government? Again, I hope you didn't injure your head too badly. Get well soon!
Posted by guest , Apr 02, 2008 10:37AM
"JPM is more than happy to take on Bear’s book of client and counterparty accounts — these were probably never in danger of being lost," ...
au contraire.
Posted by guest , Apr 02, 2008 10:43AM
I am more than happy to take on Bear's book of young female interns - employed or unemployed - as long as the book contains facial pictures (I mean pictures of their faces, not what some of you are probably already thinking).
T. Roxwell Jackson
Hiring Administrator
Posted by Anal_yst , Apr 02, 2008 10:43AM
Agreed with 10:37, on what basis does this genius make that statement?
Posted by guest , Apr 02, 2008 10:50AM
the last time the National Review got a story right...well, I'm still waiting.
Posted by guest , Apr 02, 2008 10:51AM
He didn't check with me. My firm stopped taking any counterparty risk to bear stearns months ago or trading anything but equities.
s75
Posted by guest , Apr 02, 2008 11:10AM
The National Review is being quoted? Shouldn't its name be spelled "Nazionale"? You'd do better to quote The Onion.
Posted by Investorcluzo , Apr 02, 2008 11:13AM
while I haven't read the entire story over at NR, I would offer that sometimes discretion is the better part of valor. ever hear of unintended consequences? perhaps it wasn't just the big daddy cayne and the boys/girls at 383 mad that would have been affected. we're dealing with something much larger here people...
Posted by Novice , Apr 02, 2008 11:15AM
Nomad, right instincts but wrong example.
Posted by guest , Apr 02, 2008 11:16AM
So since everything is great now, the bottom has been reached, stocks are back on the rise I guess that means we can start reversing some of these rate cuts soon and get the dollar back out of the shitter? If the crises is over then we shouldn't need any more rate cuts right?
Posted by golden girl , Apr 02, 2008 11:18AM
IC (and Analyst/10:37): agreed. while i am on the side of free markets generally, this could have been a fiasco, sweeping up at least parts of lehman, ubs, etc before the dust settled. i have no problem with people questioning the terms of what happened and making suggestions or registering complaints, but it would do everyone some good to recognize the situation that was at hand and stop overly simplifying matters in order to be sensational.
Posted by guest , Apr 02, 2008 11:33AM
So explain this "profits from the good times are retained" bit. Exactly where are all these profits, are they hidden in a vault somewhere? Are the stockholders sitting on a secret pile of gold?
I'm not much of a chart reader but this $10 level seems to have wiped out gains from 2007, 2006, 2005, 2004....
And where are the socialized losses? Last I checked the losses so far seem to have been borne by Bear executives, employees, and shareholders.
I mean really. Have I got my facts completely wrong?
Posted by guest , Apr 02, 2008 11:34AM
The Fed's action illustrates that I-banks that are too big to fail are GSEs, like Fannie or Freddie.
Posted by John Carney , Apr 02, 2008 11:36AM
Shareholders lost a lot of money. But every executive keeps what they were paid over the boom years, at least the cash portion and the stock options they already exercised.
Posted by DrederickTatum , Apr 02, 2008 11:38AM
I ask this question seriously... looking for a reasonable answer.
What was the Fed's alternative? If Bear goes BK, 10% of Wall Street assets are tied up in Bankruptcy court for a decade. The repercussions of a Bear bankruptcy would have been a nightmare for our national economy.
Nobody knows what the value of Bear's Assets are... its too hazy. Without the backstop from the Fed, I'm not certain any deal for BSC would have been possible.
I do not think opening the window for Bear would have improved the situation. They would have made MASSIVE loans from the Fed on the Monday following the deal. Then word would have leaked and then EVERY Bear deposit would have fleed to safe harbor.... resulting in Bankruptcy anyway.
Posted by DrederickTatum , Apr 02, 2008 11:41AM
by the way, I recognize that fleed is not actually a word.
Please substitute "fled" for "fleed" in my above post.
Posted by John Carney , Apr 02, 2008 11:42AM
Losses have been socialized because any losses in the portfolio of securities that the Federal Reserve bought from Bear reduce the amount that the Fed pays into the general treasury. That lost income to the government will be made up for by borrowing or tax hikes (or, perhaps, spending cuts). The general public now bears the risk of the Bear portfolio. That is socialized risk, and when the losses emerge, that will be socialized losses.
Posted by guest , Apr 02, 2008 11:50AM
$100 per person lent by Bennie and Friends for JPM to buy BSC? F that Ben! Are you nuts? Let 'em fail! It's just one firm. Not even a good firm if you ask me. For my $100 BAILOUT OF YOU MORONS, I *expect* ALL the hot female BSC/JPM/Fed employees to get down on your knees WHENEVER I WANT and provide GREAT CUSTOMER SERVICE. For the ugly ones, just be sure you've got a paper bag with a single hole cut out. That's all you need to bring to work or WHENEVER you go out at night. I leave the anal for all the more irate taxpayers (suckers)...
Posted by ab , Apr 02, 2008 11:52AM
@DT
Even if you're right, why do BSC shareholders (and bondholders to some extent) get to walk away with anything?
Posted by diablo , Apr 02, 2008 11:59AM
Carney @11:42AM
More to the point:
CNBC's Steve Liesman reports on a letter from Treasury Secretary Paulson to New York Fed President Tim Geithner. In the letter, Treasury agrees that the Fed can bill Treasury for any losses from the Bear Stearns deal.
--
And
--
The securities backing a $29 billion Federal Reserve loan to Bear Stearns Cos. consist primarily of "mortgage-backed securities and related hedge investments," the Treasury Department said.
...
The Fed has declined to provide any underlying detail so far.
--
Any chance those things could be sold at a profit? Sorry for the rhetorical question.
Quotes taken from Calculated Risk.
Posted by guest , Apr 02, 2008 12:02PM
Carney--
Then let's refer to them as socialized risks, not socialized losses. There's a very important difference.
Posted by guest , Apr 02, 2008 12:02PM
@11:33 50% of the profits were taken home as cash bonuses by the employees
Posted by arthurcutten , Apr 02, 2008 12:04PM
What may not be immediately obvious is that the Fed, which was at least putatively a member of the State Casino Commission, admittedly with connections to bankrolling key participants, is now sitting down at the table and playing.
Posted by DrederickTatum , Apr 02, 2008 12:11PM
@AB
That is a fair point... The answer is that JP Morgan still paid the purchase price - Not the Fed.
Believe it or not, BSC had value in its book of business, real estate, etc. If a stable buyer came along, the buyer restore the market's confidence in the rapidly dying BSC. The mass exodus of Bear would slow or stop altogether if a more stable, reliable entity stepped in to buy it.
The problem is that the market was exceptionally limited. Basically the market was 1) huge investment banks relatively untarnished from the subprime fallout; and 2) an institution with some knowledge of Bear's holdings and historical business model.
That was basically only JPM. Since the market consisted of essentially only one buyer, BSC had to take any deal it could get... The two dollare deal was accepted. When shareholder revolt seemed possible, JPM raised the price to $10.00 to deflate any possibility that the deal could collapse.
I would argue that the free market still worked. The pool of potential buyers was so small, BSC had to take what it could get...
Posted by guest , Apr 02, 2008 12:12PM
@ 11:59 -- You have got to be kidding me. The Treasury is going to backstop the Fed for any losses on Bear's garbage?
Where is this Calculated Risk site?
Posted by guest , Apr 02, 2008 12:13PM
Everyone should look closer at who did what to whom in this whole Bear/JPM debacle.
Consider that "white knight" Parr guy from Lazard. Called by Schwartz in desperation for "advice". What does Parr do but nudge Bear into the claws of JPM. And Parr was working for Bear? Parr was Schwartz's friend?
The Bear had the biggest hammer in this whole thing. Fed and Treasury absolutely did not want Bear to belly-up on Monday morning. Had Bear held their ground and insisted on direct access to the $30B instead of accepting the JPM pass thru, Bear might still be viable. That threat of Bankruptcy was very powerful. BSC shareholders might not be BSC bag holders today had that creep Parr done his job.
I'm sure the hero Parr and Lazard collected their substantial fees from Bear for the traitorous work he did. Did Lazard also collect from JPM?
I've been on Lazard's case before. They advised Carlyle Capital Corp too. Where is Carlyle these days?
What's Lazard doing hiding out in Bermuda anyway? Is it the hope that they might scam some of that re-insurance money down there. Maybe it's the glamor of Tucker Town.
-The Guy from Delaware
Posted by Novice , Apr 02, 2008 12:14PM
Carney, in terms of opportunity cost it's not a loss. Let's say the Fed had two options, one being sitting on its hands and the other taking the ~30bn and forcing Bear to sell to JPM. I think the net benefit of avoiding Bear's bankruptcy and greater panic were greater than any losses the Treasury will take on that $30 bn.
I'm a micro guy, so bear with me on the macro: If you say that in a counterfactual world the Fed does nothing and this results in .5% greater unemployment for a year because of greater uncertainty, turmoil, less credit or investment, whatever, then Okun's Law says that the country loses $150bn to $225bn in GDP, irretrievably.
Posted by Anonymous , Apr 02, 2008 12:22PM
Someone please offer an alternative.
Posted by diablo , Apr 02, 2008 12:24PM
guest @12:12 PM
See here and click on the CNBC video link.
http://calculatedrisk.blogspot.com/2008/04/treasury-agrees-to-absorb-any-losses-to.html
Posted by guest , Apr 02, 2008 12:31PM
Damn, look at Carney taking on all the commentator monkeys!
Carney, you should be spending you're time posting.
Posted by DrederickTatum , Apr 02, 2008 12:42PM
@Novice
Good point there...I bet the real costs of Fed "sitting on its hands" would be even greater than you suggest.
Posted by guest , Apr 02, 2008 12:59PM
Alan Schwartz heralded as a genius dealmaker. give me a fucking break
Posted by John Carney , Apr 02, 2008 1:03PM
@12:31,
Haven't you heard? I'm getting ready to go on vacation. Just one more day around these parts and then I'm off to Southeast Asia. I'm leaving this shop in the capable hands of Bess Levin and Equity Private. Today I'm busy getting ready for the trip.
Posted by guest , Apr 02, 2008 1:13PM
Weren't you just there?
Posted by guest , Apr 02, 2008 1:16PM
Wait - didn't JPM say that those securities were CONSERVATIVELY MARKED. I bet to be conservative, as they are a public company, Bear marked them down far below what losses could ever be. Especially the CMBS - they probably took them close to zero already just in case. This sounds profitable to me, this could be socialized gains.
And yes, I laugh as I write this. BSC had no options, they were finished, everyone knew it (besides the equity market), and management certainly knew it which is why they took the deal. I'll gladly pay into some moral hazard to open Monday without embarking on a full blown financial domino meltdown. Anyone who didn't see that risk is blind because you can sure bet the Fed, banks, and anyone with half a clue knew it - and that's exactly why that deal happened.
Of course now that we didn't blow up everyone seems to want to Sunday quarterback and knows of better ways. Well, where we you on over the weekend and if you are so smart how come your phone wasn't ringing off the hook to get you involved. I guess no one else has yet realized the depths of latent genius we have out there.
Posted by Anal_yst , Apr 02, 2008 1:23PM
@ 11:50
You clearly do not understand the implications of letting Bear fail. Your ignorant comment that "They're just one firm" completely fails to grasp the fact that clients, partners, customers, and even unrelated 3rd parties would all have felt the effects if Bear was left to its own.
Generally speaking, it seems as if most all of the opponents of the deal and the Fed's actions exhibit a complete lack of understanding of how the global financial system operates. I'd try to explain, but obviously that would be no more than a futile attempt.
Posted by guest , Apr 02, 2008 1:27PM
@11:50 not do you evidently have a grasp of the pricing scale of sex workers
Posted by guest , Apr 02, 2008 1:33PM
nor
Posted by guest , Apr 02, 2008 1:35PM
... so, in Goldman's mind, there was an assumption that the Fed would have to act if it forced bear stearns to fail. if I was bernanke, I would charge this $30 bn right back to 85 broad street
Posted by guest , Apr 02, 2008 1:35PM
Why Merrill Lynch is benefiting from FED funds while it's in flagrant violation of Federal laws?!!!
http://www.dealbreaker.com/2007/07/post_364.php
http://eeoc0sues0merrilllynch.wordpress.com/
That is outrageous!
Posted by Investorcluzo , Apr 02, 2008 1:41PM
@guy from DE - damn, you still writing? I thought anal_yst took care of you. where is random banker when you need him? c'mon man, are you joking: "had bear held their ground". what ground was theirs to hold? the quicksand that they were swiftly sinking into? the only chips big daddy cayne had were the ones left over from his bridge tournament, last I checked, you couldn't bargain with the FED on those...and as far as lazard getting paid, had the big bad bear fallen, they would have become a general creditor (still getting paid before the equity holders).
@carney - you can't pull the wool over my eyes, you're going over to get that mail order bride that you picked out on your last trip. I guess that means she just had a birthday so you can "legally" bring her back.
anyone remember pacific gas and electric? guess what? now all the residents in the state of california get to pay above market electricity rates until 2012 (or later) because it failed. I'm fairly certain the ceo who presided over that $hit show didn't give back any of the millions he pocketed over the years. my question to you, should the FED have let BSc go down so that all americans could pay above market rates on their mortgages for the next x years? once again I point to discretion and the unintended...
Posted by guest , Apr 02, 2008 1:44PM
From The Guy From Delaware: "The Bear had the biggest hammer in this whole thing. Fed and Treasury absolutely did not want Bear to belly-up on Monday morning. Had Bear held their ground and insisted on direct access to the $30B instead of accepting the JPM pass thru, Bear might still be viable. That threat of Bankruptcy was very powerful. BSC shareholders might not be BSC bag holders today had that creep Parr done his job."
WRONG. With a merger offer on the table that would return value to shareholders and creditors, the Bear Stearns Board couldn't take the company into liquidation, knowing that shareholders would get zero and many creditors would suffer material losses.
Threatening bankruptcy is like that scene in Blazing Saddles when the lead points a gun at his head. No one should take the threat seriously (unless they're a moron).
Posted by guest , Apr 02, 2008 1:56PM
Earlier poster talked about the limited number of possible firms to acquire Bear. Just a thought, but I wonder if there could have been more interested parties had it been known that the fed was serving as risk backstop. Second, it's suggested that JPM was one few that had its own balance sheet in order enough to be a suitor. I agree, but I thought of another potential suitor: Goldman Sachs. Was Goldman just not interested? Or was Paulsen cognizant of the appearance of giving a sweetheart deal to his old firm? If the latter, then Paulsen's Goldman-roots could have cost BSC shareholder's serious $$ in a competitive bid situation (and perhaps also cost the taxpayers as a competitive bid may have also decreased the Fed's commitment.)
Posted by guest , Apr 02, 2008 2:16PM
Guest@1:16PM...
You make it sound as though you know all the reasons why the JPM/Bear thing went down the way it did.
The fact remains...Fed walked into that meeting with $30B for somebody. They just didn't know for whom.
Fed and Treasury were not going to let bear fail. That is for sure. (See my earlier post @12:13PM).
If Parr from that Lazard outfit had been looking out for his client(Bear), the $30B would have gone directly to the Bear, and not thru JPM. For the Fed, the risk would be the same.
JPM has no downside on this, only upside. Fed has protected them from loss. The Fed and Treasury have all the risk.
I say again, look at Parr.
@1:16PM...Why didn't they call me? They didn't because they don't know me from Donald Duck. They'd rather stay with the genius they know, rather than call someone they never heard of.
I wrote about the $30B pass thru the day after it happened, and wondered why. I just didn't know about Parr's involvement until recently. He brings things into focus.
I do know this. That candy-ass Parr did one hell of a lot more damage to the viability of Bear than I could ever have done.
-The Guy from Delaware
Posted by guest , Apr 02, 2008 2:42PM
Its startling how little y'all actually know about bankruptcy and how it works. Which is what the Feds are counting on to let this go through!
Posted by DrederickTatum , Apr 02, 2008 3:05PM
@1:56
Yes... Goldman would have been another player who could have come into bid for Bear Stearns. Its possile that the Feds wanted to avoid the appearance of a "sweetheart" deal from Paulson. Goldman does have its balance sheet in order (though, IMO, it still holds a shockingly high amount of Level 3 Assets).
I believe JPM was the logical partner though for two reasons:
1) JPM was most familiar with BSC. JPM had been clearing trades form BSC trades and had a somewhat working knowledge of BSC's internals (though limited, JPM had better information than the other players). Having the best available information is hugely important when you have only 48 hours to work a deal for the world's fifth largest investment bank.
2) JPM had more to gain from the deal than Goldman. In terms of prime brokerage (Bear's specialty) JPM has been somewhat lagging. The prime brokerage business is what JPM really wants. Its demand for Bear would have been greater than that from Goldman.
Posted by guest , Apr 02, 2008 3:39PM
What do you guys think?
Maybe I should go back to looking at internet porn and forget about investment banking for awhile.
-The Guy from Delaware
Posted by guest , Apr 02, 2008 3:39PM
@1:23 I do understand it's not just one firm. The United States is a capitalistic market. So a bunch of other *stupid* firms and individuals who didn't do their dd fail. Whoop-D-Doo! Firms fail across the planet every day. If you add all of *them* up, they're a lot larger than BSC. It's just an IB. It's no different from Chrysler (which also should not have been bailed out either). It's not like IB's are lending much now anyway. Are you suggesting that ALL firms and individuals should ALSO get bailed out? Or are we taxpayers bailing out just the whiney, snot-nosed firms who have lobbyist/whores who give cash to members of the whore Congress? Let me guess - you own stock in BSC, work in a firm that will need a bailout ALSO, work for the inept Bush admin/Fed/federal agency, or just love socialism.
@1:27 That's $100 FOR EVERY CITIZEN IN THE USA. Since some of my fellow Americans are not going to use the BSC employees' sucking services, I'm using their shares as well. I'll be nice and say I'll use 37 other people's shares. For $3,700, I expect the entire GFE when I demand it of ANY hot BSC female. And girls, since I and other taxpayers are bailing out your sorry firm, you'd better not spit.
Posted by guest , Apr 02, 2008 3:41PM
Really? $10 trillion worth of counterparty exposures fail EVERY DAY?
Posted by guest , Apr 02, 2008 3:43PM
@Guy from DE - You know, I never really thought that the bargaining block over the weekend was that BSC was already dead so why not threaten to blow everyone else up too with a financial system nuke in the hopes of additional subsidy/ransom.
1) I'm not confident they had the time to play hardball or that others wouldn't call their bluff or just walk out in frustration (let's recall Bear's track record on the Street here - it's not as if they haven't made some enemies)
2) This is the ridiculously twisted psychology of a pouting infant. I'm glad this type of attitude is limited to Al Qaeda types.
Posted by guest , Apr 02, 2008 4:12PM
ON the Merrill Lynch story:
Are you saying Merrill is using Federal government dollars while it is fighting with government/EEOC?!
Hello!!! anyone in DC watching this?
What happend to Outrage, shame?
Posted by guest , Apr 02, 2008 6:01PM
John, have a good time on your trip!
I don't agree with you on the Fed Reserve loan to Bear Stearns. As you know, the Fed is self-funding. Most of its funding comes from interest and income for services performed. But the most important reason it's there is to stabilize financial institutions.
Whatever surplus the Fed accumulates that it doesn't think will be needed is poured every year into the U.S. Treasury. This is a secondary benefit to the system.
The Fed loan was collateralized by assets that had already been marked down. The interest on the loan is 2.5% and the loan term is ten years. If Bear (or eventually JP Morgan) doesn't make good on the loan, the assets belong to the Fed, and the Fed can choose to sell them at a better time in the market cycle. It will be ten years before we know if the Fed will take a loss on this. If it does, there may be less surplus at some future time to pour into the U.S. Treasury.
But making money for the U.S. Treasury was never a first priority in the creation of the Fed. Stressing the loss to the "taxpayers" is putting the cart before the horse. The Fed loan was paid out of the Fed system, for the purposes for which the Fed was established. Projecting $30 billion in possible losses to U.S. taxpayers assumes that the assets are completely valueless, and over a ten year period, the market for the assets will never recover. Those are pretty big assumptions.
Posted by guest , Apr 02, 2008 6:12PM
No one has commented much on Jamie Dimon's position on the New York Fed and a possible conflict of interest with that $30B Fed Reserve loan that worked out to his advantage.
I think that's one of the main issues that motivated the Senate Finance Committee hearing tomorrow.
Posted by guest , Apr 03, 2008 1:58PM
This morning I read that the NY Fed is opening up an LLC in Delaware to store all of Bear's bad stuff. Plan is to wait for better times so Blackrock can sell it for them. NY Fed hopes to get back some of that $29B.
Guest@6:12PM 04/02...
James Diamond's NY Fed position is the last piece of the JPM/Bear/Fed puzzle I was looking for. Thanks.
That, along with the involvement of that Parr guy from Lazard makes for the perfect mixture that poisoned Bear to death.
I don't think any of the genius posters on this string even knew of Dimon's position.
-The Guy from Delaware