Friday, March 14, 2008

Fed fights desperately to save Bear Sterns (BSC).

Last update 22:49 - scroll down.
10:30 AM: Boom! Man down! Or rather, a Bear... Just a few days ago I wrote that the next milestone would be a major bank failure, and here we have it. The news just broke that Fed is feeding discount window money to JPMorgan Chase so they could quickly provide emergency funding to BSC. The most ominous phrase in the press release was "JPM is working closely with BSC [...] on other alternatives for the company". Just imagine all those wonderful 'other alternatives'!

Twice in the last two weeks there were rumors that BSC cannot meet its liabilities, and today was the third... Like they say it, third time is a charm.

This is not small fish like Thornburg, and not even medium fish like Carlyle, this is Fed's cherished Primary Dealer!
Apparently, none of the usual rescue tools Fed keeps at hand for banks in trouble have worked in this case. Bear probably did not have enough collateral to post to borrow from discount window itself, and TSLF doesn't start for a week, so Fed is spoon-feeding them through JPM. Is it legal? Probably not. Is anyone likely to object at this point? Haha.

This is the end of Bear as we knew it. Investment Bank's main asset is credibility, and their credibility was just taken out the back door and shot. Their most likely fate? They will be bought out by JPM for pennies on the dollar.

I don't think anyone will let BSC declare bankruptcy officially, since they are a major counter-party to almost everyone dealing in derivatives, and if there is one thing Well Street and Fed are both scared witless off, it is a CDS monster.

Here is the full text of JPM's announcement to shareholders:

We announced this morning that in conjunction with the Federal Reserve Bank of
New York, JPMorgan has agreed to provide secured funding to Bear Stearns, as
necessary, for an initial period of up to 28 days. As part of our discussions
with the Fed, they have agreed to provide non-recourse, back-to-back financing
to us through the Discount Window. As a result, we do not believe this
transaction exposes our shareholders to any material risk. We are also in
discussions with the Fed and working closely with Bear Stearns on securing
permanent financing or other strategic alternatives.

This transaction speaks to the strength of JPMorgan and the advantage of maintaining a fortress balance sheet at a time when capital is at a premium. JPMorgan has a proud history of partnering with the Fed and other government entities to help during turbulent markets. We're pleased to work with the Fed to help Bear Stearns with its current liquidity concerns.

We will continue to update you as things progress.

UPDATE: 17:30PM:

I have a few more details now, and WSJ has also updated their article with more information. Apparently, the move by the Fed was (barely) legal - they used a little known provision in Federal Reserve Act. This provision was added during the Great Depression, which before now was the last time Fed had to prop up a failing banking system. However, as Business Week notes, provision or not, the move will be questioned by banking experts and politicians, and many consider it to be outside of Fed's mandate (you bet it is!). This is the first time in history that Fed stepped in and saved an investment bank.

Also, Bear was not eligible to borrow from discount window itself (not that it had collateral, anyway!) because it does not have commercial bank license. That's why Fed had to reach them through JPM. Bear is an investment bank and a brokerage. Again, this is a moot point because Bear is certainly out of any eligible collateral to borrow from Fed.

Another observation - note that JPM's letter to shareholders says that JPM is not taking on additional risk. If you wonder who is taking on additional risk, then I am sorry to disappoint - it's YOU. Unless you pay taxes abroad, that is. It is quite obvious that loan made to Bear cannot and won't be repaid. One has to wonder what kind of guarantee JPM received from the Fed...

On a final note, Bear Sterns was founded in 1923, survived several vicious crises and has never had a yearly loss until 2007. That's right, not even during the Great Depression. It was a glorious journey, and what a spectacular ending!

UPDATE: 19:08:
Professor Roubini weighs in with an angry I told you so! As the great prophet of this catastrophe, he deserves credit.

UPDATE: 19:45:
Bear Sterns makes a public statement during a conference call and acknowledges that it may not survive. While this may seem like non-news, it does bring up an interesting question: do they mean they will be bought out, as I suspect, or do they mean they will really be allowed to default? The problem with buying them out is that their liabilities far outstrip any value they have, so who in their right mind would pay a positive amount of money to buy them? The problem with letting them default is that it will trigger a derivative unwind that may bury the entire Wall Street alive. Another stalemate (or checkmate?) for the Fed to ponder over the weekend.

UPDATE: 22:49:
Wall Street Journal brings us this gem: It Is Tough to Value Bear, But It Had Better Sell Fast. It is good for a few laughs if you are a misanthropic type and like schadenfreude. Otherwise it's plain depressing. WSJ grimly tells us that the only asset BSC has that is likely to have any real value is their office building. I see this building every day, and it's a nice building, but it's exactly the kind of thing you would rather not own today. Although it may be convenient for JPMorgan, since it is just across the street from two of JPM's own towers.
Bear says it is frantically searching for a buyer and want to find one in a few days. This is understandable, because in a couple weeks no amount of Fed money may save them from default.
The problem is, nobody on Wall Street would buy them right now. Not only is everyone out of money, who would want to take on Bear's liabilities and its bag of MBS, ABS and all other toxic securities?
This is the ultimate nightmare scenario for the Fed. They will have to bring in politicians, and fast. Depending on what they do, this may the proverbial mis-step by the government that brings the whole house of cards down.

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