From the Wall Street Journal:
Amid heightened concerns over the state of the world financial system, George W. Bush gave assurances Monday that capital markets are working smoothly, adding that the US is “on top of the situation.” Read more
There has been much fuss lately about distorted incentives in bankers’ pay that encourage them to take excessive risks because they do not suffer the full consequences of failure. I have written about it myself.
The Bear Stearns collapse shows the other side of that argument. Financial News estimates that Bear employees, who own about a third of the equity through stock bonuses and pension savings, have just lost a collective $5.2bn based on the sale price to JP Morgan compared with the share price of Bear in December.
Even divided among 14,000 employees, that is plenty of money. Because of the way in which bonuses are paid on Wall Street these days, with the bulk issued in shares that only vest after three to five years, they had little choice but to be heavily invested in the fortunes (and now misfortunes) of their bank. Read more
The other day, I listened to a New York financier bemoaning the furor in the US about investments by sovereign wealth funds in US financial institutions. His argument was that SWFs have a choice about where to invest and the US is in no position to be fussy. It needs the capital. Read more
There is one thing about being a central banker in the UK or the US. Most of the time, it sounds like a pretty dull business of looking at economic statistics and deciding whether to move interest rates a quarter of a point in either direction. Every so often, however, there is an adrenalin-filled weekend in which you get to decide whether a financial institution survives or goes under.
Last night, I reckoned the Fed had done a good job of balancing moral hazard with financial uncertainty by manoeuvring Bear into the hands of JP Morgan for a knock-down (actually negative) price and only having to stand behind $30bn of assets. That looked like a better outcome than the Bank of England had managed with Northern Rock.
In the cold light on morning, with the US markets open and Armageddon apparently postponed, I think that observation stands. But, of course, the difference between Northern Rock and Bear Stearns is that the latter is not a deposit-taking institution and the only run on the bank was from hedge fund customers withdrawing from its prime broking business. Rescuing hedge funds and other counter-parties is not the ordinary business of the Fed.
So how did the Fed do in terms of avoiding moral hazard? Let us take the parties in turn. Read more
Go back a few weeks and the idea that JP Morgan Chase would have been able to snap up Bear Stearns for $230m – a big discount to the value of its Manhattan headquarters, never mind the remainder of its business, would have been laughable. But that is what has just happened.
The reason that JP Morgan could get such a bargain deal is, of course, that Bear would have collapsed last week without the intervention of the US Federal Reserve, which gave Bear an emergency funding guarantee.
The Fed followed up on Sunday by guaranteeing funding for about $30bn of Bear’s less liquid balance sheet assets, which gave JP Morgan comfort that it can de-leverage Bear’s balance sheet without too much pain. More pain, that is, than it is pricing in with its low-ball offer.
Any time that a central bank steps in to rescue a financial institution, it had better have a good defence to those who argue that it is interfering wrongly in markets and promoting moral hazard. Read more
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