On Tuesday, March 11, Federal Reserve Chairman Ben S. Bernanke lunched with what Bloomberg is describing as a “Who's Who of Wall Street leaders.” Attendees JPMorgan Chase 's Jamie Dimon, Goldman Sachs’s top dog Lloyd Blankfein, Lehman Brothers boss Richard Fuld, Morgan Stanley President James Gorman, Citigroup’s consigliore Robert Rubin, Blackstone Group’s little big man Stephen Schwarzman and Merrill Lynch’s John Thain.

Guess who wasn’t at the lunch? If you answered “anyone from Bear Stearns” you’d be absolutely right. Now some are speculating that Bear Stearns may have been purposefully excluded because its fate was one of the topics of discussion.

“It doesn't seem credible that just about every major financial institution in the United States, except Bear Stearns, had a meeting about the most pressing issue of the day, bank liquidity, and the subject wasn't about Bear Stearns, who had rumors swirling about them since Monday,” Eric Salzman at the Monkey Business blog says.

What was discussed at the luncheon has not been revealed. Bloomberg News obtained Bernanke’s schedule and the list of attendees in response to a request under the Freedom of Information Act. But the timing seems is jarring. Rumors of liquidity troubles at Bear had prompted the bank to issue a denial the day before for the lunch. On the preceding Friday, one bank (which has not been identified) refused to make a short term loan of $2 billion to Bear. The meeting came hours after Bernanke announced plans to lend $200 billion of Treasuries in exchange for debt including mortgage-backed securities. Hours after the meeting every bank on Wall Street reportedly began refusing to issue credit protection on the debt of Bear. Two days later Bear Stearns chief executive Alan Schwarz would be forced to call Dimon to seek $30 billion in emergency funding.

Update: Was Bear left out because its top two men were out of town? If we recall correctly, Schwarz was down at the Bear Stearns Media Conference in Palm Beach around this time, and chairman Jimmy Cayne was flying out for a bridge tournament in the midwest.

Bernanke Lunched With Dimon, Rubin Before Bear Rescue [Bloomberg]

We’ve finally gotten around to reading the words that the Bearded One spoke at Columbia Business School on Monday night. Stitching together his various proposals, it’s clear that Ben Bernanke has become a partisan of big government. The way we read it, he pretty much calls for the federal government to bailout lenders who have provided mortgages for homes that have suffered major declines in value.

At one point in the speech, Bernanke called on Congress to expand the Federal Housing Administration, both in terms of its role in issuing mortgages and determining underwriting strategies in order to help “troubled borrowers.” How does he expect the expanded FHA to help? By bailing out lenders with mortgages where the principal is now worth more than the value of the home.

“In some cases, when the source of the problem is a decline of the value of the home well below the mortgage's principal balance, the best solution may be a write-down of principal or other permanent modification of the loan by the servicer, perhaps combined with a refinancing by the Federal Housing Administration or another lender,” Bernanke said.

In other words, the Federal government should step in to refinance loans in danger of defaulting due to the decline in housing prices.

When Bear Stearns looked like it would go for $2 a share, there was a lot of sympathy for investors who stood to lose tremendous amounts. Employees—who own about a third of Bear—faced not only losing their jobs but their savings as well. So when they gnashed their teeth and hollered that their firm was being stolen by a conspiracy led by the Fed and carried out by JP Morgan Chase, it was just plain polite not to point out that their firm was on the verge of bankruptcy, that its failures had arguably put the larger financial system at risk and that what little they were getting was the result of a government-led bailout.

But now that the price of the deal has risen to ten dollars and shares are trading even higher than that, the backlash has begun. Writing for Smart Money, James Stewart writes that the protests against the rescue of Bear Stearns from insiders are “galling.” What’s more, it shows the Wall Street is all too willing to seek a government safety net when it stumbles on its free-market high-wire act, he argues. The profits from risk are private, but the losses are all too public.

Having artfully solved a thorny problem a week ago, the government has now embraced a deal whose terms reek of the bailout it was at such pains to avoid. If the government is willing to bestow such a windfall on a James Cayne, where will it it stop? Why should other financial firms reduce risk and shore up their capital? What discipline will the market ever be able to impose? Future disasters will only be worse, which will dwarf the immediate cost of the current rescue.

Yves Smith at Naked Capitalism is even more blunt, and he criticizes the media for being too sympathetic to Bear’s employees and investors. “Bear was going to fail as of Monday,” he writes. “Bye bye equity and many if not most jobs. How hard is this to understand? I thought anyone who was remotely financially literate understood what bankruptcy means. The employees should be grateful to get anything. But no, the media slavishly accepts their sense of entitlement.”

No Tears for Mr. Cayne [Smart Money]
Bear: Did the Fed and Treasury Push Too Hard? [NakedCapitalism]

So the Federal Reserve decided to defy market expectations and the predictions of most Wall Street economists that it would cut 100 basis points from the Fed Funds target rate and delivered only a 75 basis point cut. Economists for Citigroup, Morgan Stanley, Goldman Sachs, Standard & Poors and Bear Stearns all called it wrong.

DealBreaker’s readers did better. The chances of a 75 basis point cut ran neck and neck with the chances of a 100 basis point cut for most the morning and early afternoon. As the Fed announcement approached, however, the votes for a 75 basis point cut pulled ahead. Thirty-nine percent of readers voting in the poll favored 75 basis points, and 34.% favored 100 basis points. Joseph LaVorgna, chief U.S. economist at Deutsche Bank, also called it right by predicting a 75 basis point cut.

The market then also defied almost everyone’s staging a tremendous rally after the news broke. Goldman Sachs had warned that “anything less than the almost [one percentage point] that is now discounted will risk an adverse market response that could aggravate the fragility Fed officials are trying to repair.” Well, at least in terms of the immediate market reaction, that prediction seems dead-wrong.

Why the rally? We don’t like to offer explanations for movements of broad stock market indexes. But we do think the Fed statement probably reassured many investors by re-iterating the Fed’s awareness that the economy is in peril and repeating its new mantra about being prepared to take further action should things deteriorate. What’s more, there was something comforting in the display of a Federal Reserve confident enough to defy the clamoring of the Punch Bowl Caucus. From a Fed that has lately seemed to only ask “how high” whenever Wall Street has said “jump,” those 25 points of defiance are a welcome sign of independent judgment.

We hate to interrupt yet another rendition of the Wall Street chorus singing "Happy Days Are Here" again but today's rally could use a little sobriety. We're sure it is wonderful news that the Federal Reserve has convinced the central bankers of the world to cooperate with its plans to snatch, well, something or other from the jaws of recession. But no amount of coordination, no amount of monetary injections, no new levels of central bank creativity is likely to solve the underlying problem of mispriced assets.

The now popped real estate bubble unleashed a torrent of malinvestment so deep that it seems a new class of credit products freezes up (or melts downs) ever week. The newspapers read like a bowl of alphabet soup each morning. Some days we half-suspect that we're being put on, that the best and brightest of Wall Street cannot really have fallen for things such as auction rate securities.

Apparently the central bankers are convinced that what must be avoided at any cost (or at any inflation rate) is a reckoning of values. They believe they can control stock prices and prop up credits until, well, indefinitely it seems. When one bubble pops, start blowing another.

The Fed's moves today, following so closely on the Dow Jones falling to its lowest levels of the year, smacks of desperation. We avoid as best we can speculation about market movement. But as the euphoria of the moment wears off, we cannot help but expect the rally will fade as well.

But back to the chorus, lads and lasses. Pop that champagne. The central bankers are riding to the rescue, doling out the punch, and the grand Wall Street nemesis Eliot Spitzer has been laid low. Enjoy it while it lasts.

Consider the Sport Illustrated Swimsuit Issue Indicator.

Well, the 47.5% minority of those polled at DealBreaker got it right. The Fed announced a cut of 50 basis points in the target rate and the discount rate, meaning we've seen 125 basis points slashed off the Fed Funds target rate in the last week or so. As far as we can remember, this has never happened.

There will be some who wonder whether or not the Fed is misreading economic and market conditions. It notes that credit has tightened despite the easing of the commercial paper market, the refinancing jump in mortgages and a lower LIBOR. Still, it's the cut that market wanted. Stocks jumped, bonds and the dollar declined. What was that we were saying about converting the dollar into a gift card with a short expiration date?

One thing that's clear is that the Fed has become a lot less predictable, at least on any long-term basis. Two weeks ago, the chances of a 50 bps cut barely registered in the futures. And since then they've jumped all over the place. So it seems that the market isn't sure what the Fed is going to do week to week. Or perhaps it's the Fed that isn't sure.

The full statement after the jump.

Just in case you missed it last night, we're bringing the reader poll on today's Fed decision back to the top of the page. There's about an hour left to vote for this before we shut down the poll and start gearing up to cover the aftermath.

What a difference a day makes. Just two days ago, DealBreaker's reader poll revealed an almost even split between those who thought the Fed would today announce a 50 basis point rate cut and those predicting a 25 basis point cut. The 50 bps cut had a slight edge, in fact.

Late yesterday we began a new poll asking about the cut, and it shows a dramatic shift in sentiment. The 25 bps cut now leads decisively, garnering support from 58.2% of responding readers. Good economic news, perhaps coupled with suspicions that last Monday's sell-off and subsequent emergency rate cut was sparked by SocGen selling off positions by their allegedly rouge trader, seems to have persuaded many readers that the Fed cut won't be as deep.

Others have begun to argue that the Fed won't cut deeply today in order to preserve some dry powder for later cuts.

"Bernanke has the choice of give his all (meaning 50 to 100 bp) and seeing the market rise briefly, then fall under the weight of ongoing reality. Or he can do 25bp, and watch the market fall," Finn of the Blax Alternate blog argued in comments. "With the small cut, he can save face and and say, 'Well, we could have propped the market if we wanted to, but are being responsible' (all the while praying the market rises). With a 50bp cut or more, he basically tosses all his power into the ring, only to demonstrate to all that the Fed is powerless (as well as desperate, and foolish)."

Becky Quick made a similar argument this morning on Squawk Box.

This shift occurred prior to the release of data this morning showing that the the U.S. economy slowed sharply in the fourth quarter of 2007. Gross domestic product rose at a seasonally adjusted 0.6% annual rate October through December. These numbers were likely available to Ben Bernanke yesterday, and so may have already played a role in the FOMC's rate cut discussions.

Following this morning's economic reports the widely expected 50 bps cut from the Fed became a little less widely expected, with the futures showing a drop from 86% to 72%. An internal poll at Morgan Stanley, however, showed the opposite, with 73% of respondents predicting only a 25 bps cut, according to an email sent to clients this afternoon.

Our own polling, which had over 1,700 respondents, showed almost an even split between a 25 bps cut and a 50 bps cut. No other position got a significant number of votes. So we’re asking again, with just two options.

The last of the initial round of Term Auction Facility offerings is today, with the results expected to be announced tomorrow. Does this strike anyone else as strange timing?

The FMOC is set to meet for the next two days, and everyone seems to expect that the Federal Reserve will announce a rate cut on Wednesday. (In our poll this morning, a cut of 25 basis points trails close behind a cut of 50 basis points). Should this rate cut make it hard to know where to bid in the auction? If the Fed cuts more than expected, it may wind up penalizing the banks with bid for the TAF. If it cuts less, it could wind up giving them an especially generous deal. This no doubt puts added pressure on the Fed to cut exactly where the market expects, at the fifty basis point level.

Our polls have an excellent track record of correctly calling the Fed's interest rate moves. The masters of the economy meet again this week, so it's time for another reader poll!

We spend a lot of time picking on the columnists at the New York Times business section, particularly Ben Stein and Gretchen Morgenstern. They can be fun to read simply because they are often so laughably wrong. But, laughing aside, the best economic columnist at the Times doesn't write for the business section at all. He writes for the Op-Ed page as an occasional contributor and his name is James Grant.

This past Sunday he delivered the not-exactly laughable message that pushing down interest rates to below the measured rate for inflation is not exactly a way of building a healthy economy.

Last week, as the Fed delivered its emergency cut of three-quarters of 1 percent, dropping the funds rate to 3.5 percent, the cost of living was rising on the order of 4 percent a year. Yet inflation was almost an afterthought in the press release in which the Federal Open Market Committee, the central bank’s policy-making arm, explained its surprise intervention: “The committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.”

If stability leads to instability, it follows that instability will eventually restore tranquillity. But first must come the tallying up of the errors, misjudgments and outright criminality that blossomed during the Great Moderation. Mr. Bernanke, in an attempt to limit the damage and hasten the healing, is likely to keep the Fed’s rate low — lower, even, than the measured inflation rate.

Fed funds and discount window. The talk all morning has been that this was coming. The Fed had no stomach for testing the lows.

Why did the Fed swing so hard in favor of cuts? It's hard to escape the impression that the Fed is taking orders from the stock markets. Forget the blather about credit and housing markets; the Fed could have waited till the regular meeting to deal with those problems. Today's cut is all too clearly a response to the action in the global equities markets. So what is the market saying now? The fed fund futures market is already predicting/demanding another cut at the regular meeting at the regular meeting. Cramerica is saying that this cut is "too little, too late."

Our sources say that the view within the Fed right now is that there's at least another 25 basis points coming at the end of the month. But the view within the Fed keeps changing every few weeks, so maybe we should stop wondering what the Fed is planning.

Full release after the jump.

The best part of our day, apart from lunch at Bobby Van’s, happened when Congresswoman Marcy Kaptur started praising Fed Chairman Ben Bernanke’s for his role running Goldman Sachs.

It seemed to have made the day of a lot of others too, because laughter immediately filled the room.

"Did I get the wrong firm?" she asked.

Sorry lady. You got the wrong guy altogether.

Bernanke didn’t let her hang for very long. Through a thin smile he said, "I was chief executive of the Princeton economics department."

Apparently Kaptur was confused about which bald headed lord of finance she was speaking to.

Is the Fed's announcement that it's going to start to try and prevent questionable lending practice NOW kind of like Jamie Lynn Spears's boyfriend saying, "Hey, I'm going to run out to the Duane Reade for condoms, you need anything? Gatorade? Q-tips? (Oh, and by the way, do you have any money I can borrow?...I'm good for it...)" THIS MORNING?

Perhaps the most surprising discovery we made today was the high value the Federal Reserve is willing to assign to some of the asset classes that have lately been causing so much turmoil in the markets. Even as some banks have said that the value of their CDO portfolios is unknowable and the ratings agencies have been mercilessly—if belatedly—downgrading formerly highly rated debt securities, the Federal Reserve has announced it will pay 85 cents on the dollar for CDOs with no market price available. That sounds like a pretty sweet deal in today’s markets.

It’s almost as if the Fed hadn’t been paying attention to the recent turmoil in credit markets. Don’t they know there is widespread skepticism about even triple A rated debt paper these days?

And, apparently, they haven’t been paying attention. The documentation the Fed has provided for collateral values became effective on September 22, 2006—over one year ago! Aside for some minor changes and the addition of some explanatory material at the bottom of their collateral valuation chart, the spreadsheet has not been changed to reflect the repricing of debt in the market place.

Basically, the Fed is turning back the clock on the CDO market. It’s 2006 all over again, boys and girls.

Just in case you need the summary version of our earlier post on the new Term Facility Auction, here’s a quick bullet point list of the highlights.

• The Fed will inject $40 billion into the markets in four auctions.
• Banks bid on what interest rate they will pay, which is effectively capped by the discount rate.
• Fed is taking a wider variety of paper, including CDOs and asset backed securities for which no market price is available.
• But they won't take already downgraded, junk CDOs that aren’t trading anywhere.
• The point of this is to make a market—or provide liquidity to the market—in CDOs and other recently illiquid assets. People have begun to call it a "bailout."
• Full list of collateral values is available here.

It should come as no surprise that there are many investors who believe that the primary obligation of the Federal Reserve is not to preserve the value of our currency but the values of their portfolios. But what was surprising is that so many of them also believed, at least until yesterday, that the Federal Reserve shared this tenet of their bullish faith. And when the Fed yesterday seemed to announce its heterodoxy they reacted by all but calling for the a burning of the heretics, who they were suddenly dismissing as “ivory tower” egg-heads. If only the Fed was run by more of their kind—investment fund managers and equity traders—it might make its operations more convenient to their strategies and force the markets to behave according to their models.

But it seems the governors of the Federal Reserve have redeemed themselves in the eyes of the Wall Street faithful, at least for a few hours, with the announcement today of a temporary “term facility auction.” You will be forgiven for not immediately understanding why this new creature marks the return of Ben Bernanke’s congregation to communion with Wall Street. Indeed, so new is the Term Facility Auction that never before has that phrase been uttered by a speaker of the English language—or at least, it has not before today appeared on that vast collection of their words we call the world wide web. A google search for the phrase turns up nothing before today’s announcement.

So what is this term facility auction? Our answer after the jump.