March 25, 2008
Bailing out (sic) Bear Stearns
The markets were thrilled by J.P. Morgan’s quintupling (to $10 a share) its offer for Bear Stearns. But does this not make the whole operation, from a public-policy point of view, look like even more of a shambles? The Fed explained that its $30 billion of support for J.P. Morgan, secured against Bear’s most dubious assets, was not a bail-out because Bear’s shareholders were being wiped out. Well, now they aren’t being wiped out. The more general point is this: having secured Fed support for its purchase of Bear, is it now entirely a matter for J.P. Morgan how much it pays for the bank? (The Fed has apparently participated in the revised offer. The terms of its support have been adjusted: it is no longer standing behind the first $1 billion of Bear’s impaired assets.) Was the Fed’s support for the deal in the first place conditional on the price J.P. Morgan was going to pay, or not? To say that the authorities are making this up as they go along is putting it mildly.
I agree with Lex’s take:
Where does this leave the Fed? Outwardly better off. Under the new deal, JP Morgan guarantees the first $1bn of losses on the $30bn of illiquid Bear assets the Fed originally took on. But it also means that the Fed loses its sacrificial Bear. Its intervention has given shareholders $10 a share instead of zero. (Lehman shareholders did even better from the Fed. Lehman’s shares soared from their lows in large part because its future was guaranteed by the Fed’s decision to give investment banks access to the discount window.)
Moral hazard is returning to the fore. When the smoke clears, the Fed must get its pound of flesh by regulating Wall Street, and doing it more aggressively, to make sure this never happens again.
The playing field has changed. Bernanke is right in recognising that his existing mandate–or the one that was perceived until a few weeks ago–is inadequate. He faced a moral dilemma on Bear Stearns, but is it clear that he struggled on the moral hazard? Or is he subscribed to the theory that the world turns on US consumers’ disregard for the meaning of the word “debt”?
Bernanke appears to be somewhat singlehandedly rolling out unproven solutions without any apparent checks and balances in the process. Alan Greenspan, whom Hillary Clinton is now presumably claiming amongst her advisors together with Robert Rubin, also expanded the role and mandate of the Federal Reserve. His Revisionist approach is root cause for much of the imbalance observed today.
US exceptionalism is a reality, but it is also true that the US is less dominant in today’s global economy than a decade ago. Looking at this crisis through the US political economy may be exacerbating underlying structural imbalances. It is not clear that Bernanke’s designs and models are suit the rest of the world.
If not, then the risk detailed in other recent articles of decoupling and a quick move out of the dollar as the reserve currency may hold more immediate relevancy than sceptics or those in denial are ready for. For interests outside the US I see less and less reason for confidence in Fed or Treasury policy making that is aimed at saving the very banking system that got us into this mess. If I was in a dollar-pegged economy, I would have reason for serious doubt.
Lastly, JPMorgan’s upping of its offer for Bear Stearns and other recent transactions and noise have raised serious questions about valuation processes. Do auditors and analysts have a serious clue as to what they are workign with?
Posted by: WCM | March 25th, 2008 at 2:08 pm | Report this commentBailing out Bear Stearns is the ultimate deception by the Bush White House.The decision by the Fed to bail out Bear Stearns was,in my humble opinion, a political decision.It sends out to the worldwide audience of this drama the wrong message,and NOT for the first either.The credibility of the Fed and its chaiman have been diminished by this action,no manner what Wall Street excuse you want to listen to.The whole process has a comic opera feel to it,just imagine here you have Senior Managers and executives living the kind of life style that no reasonable man or woman can aspire to(homes in the Hamptons,Private Jets…etc)and the federal government bails them out with taxpayers’s dollars,is anyone watching the store?????
Posted by: raymonda | March 27th, 2008 at 3:40 pm | Report this commentWho is the writer of the Lex columns?
They sum up the story very well.
Posted by: Bhavin P. Kapadia | March 31st, 2008 at 5:51 pm | Report this comment