the visible hand

it is the theory which decides what can be observed – einstein

Too big to fail? Put it on the taxpayers tab…

Posted by ecoshift on April 2, 2008

A couple days ago the market shot up 400 points. Since most of the news on the economy was bad or at best mediocre it’s hard to understand why.

Some commentators guessed that it was because oil prices were down, or because the continuing huge write downs at the investment banks meant that finally, at last, the worst was over and it was time to buy equities again. Or perhaps it was because UBS and Lehman, in serious need of capital, seemed likely to actually raise some scratch. Based on what kind of projections or assumptions about future markets I don’t know.

But, the best explanation is this: The New York Fed actually got the treasury to back the 30 billion dollar buyout of Bear Stearns by JP Morgan. JP will take the first billion in losses, the taxpayer the rest.

This is what you call a precedent. The more so because it’s unprecedented.

If you are not paying attention, now might be a good time to begin. The investment bank bailouts are now directly secured by your money. No wonder the market is reassured, you’re taking all the risk and you’re not even asking for a reasonable share of any upside on these bargain basement fire sales. JP will owe you big time if it all works out, but I doubt that you have it writing.


David Freddoso on Bear Stearns Bailout on National Review Online
April 2, 2008 4:00 AM
Bear with Me: The mother of all government bailouts.

The short version of this story is that last year, Bear Stearns began to regret its decision to invest heavily in securities backed by subprime mortgages — lightly traded assets that throughout 2007 became increasingly difficult to offload. With billions sunk in securities no one wanted, Bear’s stock took a severe beating, falling to $80 by March 3, 2008 — down from $150 the year before. Their subprime exposure finally caught up with Bear around the Ides of March, when its clients panicked and its stock price fell off a cliff. The company had two choices: bankruptcy and the sale of its assets, or a buyout by rival JPMorgan Chase (JPM), backed by the Federal Reserve Bank. JPM’s initial offer of $2 per share has since been raised to a still pitiful $10.

The government’s involvement here is highly irregular — the March 28 report from the non-partisan Congressional Research Service sheds light on just how bizarre the terms of this deal really are. To begin, the Fed has not used this statutory power to bail out a bad company since it was first enacted during the New Deal. Ironically, the bailout is only legal because no private firm would ever agree to its terms. As the governing statute states, the parties involved must be “unable to secure adequate credit accommodations from other banking institutions” for the government to interfere in this way.

“Nothing like this has ever happened,” says John Carney, editor of the financial blog “There isn’t even a court precedent related to this. We’re reaching back to a power they were given ages ago, that nobody thought they would have to use. Suddenly, here they are, pushing JPMorgan, perhaps the only American bank that could do it, to make the deal.”

Even in a sophisticated financial world light years away from the New Deal, the Federal Reserve Bank felt Bear was “too big to fail” — or at least “too connected to fail” — because it was so deeply involved in so many aspects of the homeownership economy. In order to force a buyout, it offered JPM a sweetheart loan, the likes of which no student borrower has ever seen. The $29-billion line of credit comes at the discount interest rate — currently 2.5 percent — over 10 years. This is a rate normally restricted to overnight loans, applied only in special cases to loans that last as long as four weeks.

The only collateral for this loan is the $30 billion in Bear Stearns’s un-sellable mortgage-backed securities, the real value of which is — shall we say — difficult to assess when no one is buying. And unlike most loans the Fed makes, it has no recourse here if the collateral loses some or all of its value. In fact, the CRS report notes, “[T]he agreement has some characteristics more in common with an asset sale than a loan.” The report adds dryly that JPM was unwilling to hold onto these assets itself, perhaps because it “could have believed that the assets were worth . . . significantly less than the current market value of $30 billion.”


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