March 14, 2008
Bear Stearns is, in fact, in trouble
On the Bear Stearns conference call this afternoon about its rescue by JP Morgan Chase and the Federal Reserve, Alan Schwartz, chief executive of the troubled investment bank, argued that its funding problems were due to outsiders not having distinguished between “fact and fiction”.
He seemed to mean that, if investors and lenders had paid attention to Bear’s assurance earlier this week that it did not have liquidity problems, then it would not have had liquidity problems.
Here is an extract from Bear’s Tuesday statement:
Bear Stearns today denied market rumors regarding the firm’s liquidity. The company stated that there is absolutely no truth to the rumors of liquidity problems that circulated today in the market. Alan Schwartz said: “Bear Stearns’ balance sheet, liquidity and capital remain strong.”
Here is what Mr Schwartz said in today’s official statement:
Bear Stearns has been the subject of a multitude of market rumors regarding our liquidity. We have tried to confront and dispel these rumors and parse fact from fiction. Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated. We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations.
Of course, as Mr Schwartz knows quite well, the line between “fact and fiction” - or liquidity and illiquidity - is a fine one and it disappears in moments of crisis. If another bank thinks you are illiquid then it will not lend you money, so you are illiquid. Perception and reality become the same, no matter how you parse them.
Official assurances that a troubled institution has no liquidity problems are virtually worthless, as the Northern Rock case showed in the UK last year. Banks ignore such proclamations and are unwilling to commit wholesale funds when there is a hint of serious trouble at a counterparty.
Worryingly for retail institutions, individual investors also seem to have taken this lesson to heart. As one investor in the queues outside Northern Rock branches to withdraw deposits aptly put it (I paraphrase): “If other banks do not want to lend it money, then why should I?”
Mr Schwartz may be right in that Bear did not have a liquidity problem earlier this week, although it did not provide a lot of evidence to that effect beyond his statement. But that “fiction” was turning to “fact” even as the statement was issued. It is a waste of time to try to reinstate the line now.
Damn right!
Posted by: nick shaw | March 14th, 2008 at 7:45 pm | Report this commentThe finance markets and companies that operate within them operate on a different planet to the ordinary man in the street. This environment is run by people who are paid enormous salaries to make daily decisions which affect us all. Sooner or later the wheels were going to come off that bus as one risk too many was taken and the snowball took off. Now we have to hope that those highly paid decision makers can figure out how to put the wheels back on, with as little collateral damage for the man in the street as possible. If they lose their own personal equity it will bring home a useful lesson that it isn’t just the man in the street who has to lose out.
Posted by: Andrew | March 15th, 2008 at 12:57 am | Report this commentCapitalism is by nature brutal competition with winners and losers. It is the competition and more suscinctly the threat of elimination that instills discipline in participants. The Greenspan and now Bernanke put removes much of the fear of elimination. Bear is a perfect case in point. What the heck happened to the free market with winners and yes, losers? If we want a healthy economy we must stop doing two things: rescuing failures and giving away free money. When we rescue failures we remove the darwinian market discipline, perpetuate poor business practices and in turn punish the victor by denying him his rightful market share and increased profit- the rewards of successful participation in the capitalist system. Free money, defined as below the real rate of inflation, encourages speculation in marginably viable business models. This wastes capital and human resources reducing precious productivity. In both cases we do nothing more than build layers of interdependent and unsustainable enterprises that ultimately leave behind unpaid debt, displaced workers devalued commercial real estate and a diminished tax base.
Posted by: gym-bob | March 15th, 2008 at 2:08 am | Report this commentLike the previous post said, every cycle must witness creative destruction or capitalism cannot move forward. The penny had to drop somewhere.
Posted by: Astro | March 15th, 2008 at 4:39 am | Report this commenti think the question of whether the incentive structure is altered by a bailout depends on whether the problem is a systemic one or intrinsic to the bank’s strategy. that’s something we can pick apart after the storm. in the meantime these are as the chinese curse goes, interesting times. and frankly i don’t think we have enough instruments to sort this one out. pity….
Posted by: tahir iqbal | March 15th, 2008 at 12:29 pm | Report this commentMy friend Tahir Iqbal has made me think and afterall that is the best reason to participate on Mr Gapper’s site. We may disagree about the impact of bailouts on the health of the economy but his comment that “we don’t have enough instruments to sort this one out” has been ringing in my head. Moving beyond disagreements about villans it is more productive to begin dialogues about solutions.The old remedies aren’t working.Please consider this;if Bear,Ambac and MBIA were to fail it would not create a significant systemic risk except for their roles as counterparties in the $45 trillion derivatives markets. Why don’t we allow the central bank to assume the county party risk thus removing the undercapitalized failures(Bear,AMBAC,MBIA etc) from the equation. This removes the fear of countyparty default and will support underlying asset prices at a significant savings to taxpayers who would only be on the hook for actual default values and not the bloated management and infrastructure. Real liquidity could be restored.This may allow a well conceived unwinding of the faulty derivatives market model while creating a window of opportunity to build a regulatory environment that prevents weak links from triggering contagions in the financial superstructure. The lock up of credit markets is tied to countyparty risk and rightly so. It also acts as a “short” on the housing mkt. Lenders wont lend thus pushing prices ever downward searching for the mythical price equilibrium point. The housing markets have S/D issues that will be exacerbated by demographics but this may put a brake to the price downdraft.It just an idea but a new one for me. Thank you Tahir and Thank you Mr Gapper.
Posted by: gym-bob | March 16th, 2008 at 2:19 pm | Report this commentAnyone relying on ST funding to support an illiquid balance sheet is at risk in these markets, and many many institutions probably fall into that category.
I’m surprised that Mr. Schwartz has come in for so much criticism for the apparent discrepancy between what was said on Tuesday and Friday.
A banker can never admit that the game is up, for then it most surely is.
I am also surprised at how many criticise the Fed for stepping in. The markets are disfunctional enough and another tsunami of forced liquidations would leave the whole financial system yet more underwater.
In short, I don’t see any alternative except to seek to extend liquidity, and demand (in return) that institutions raise capital on whatever terms they can, while the great unwind grinds on.
Posted by: kim | March 16th, 2008 at 6:05 pm | Report this comment