March 25, 2008
Moral hazard, here we come!
And there was naive me believing that in the entire Bearn Stearns/JP Morgan debacle at least one tiny blow against moral hazard had been struck: the Bear Stearns shareholders would get next to nothing under the $2 per share offer from JPMorgan. But no, Easter brought resurrection from the dead also for Bear Stearns shareholders. JPMorgan is now offering them $10 per share. Bear Stearns management and board are still in situ, of course.
All this had to be signed off on by the Fed. So what did the tax payer get in exchange? Well, the $30bn de facto first-loss guarantee for Bear Stearns’ cruddiest assets has been changed to JPMorgan taking the first $1bn loss and the Fed the next $29bn. A billion here, a billion there, but you are still not talking real money. Under the new deal, JPMorgan no longer guarantees Bear Stearns’ liabilities for a year even if its offer were voted down. That ought to be worth a few billion to JPMorgan.
So what the tax payer gets out of this is the first $1bn of its old guarantee in exchange for a warm embrace of moral hazard. There is also the nice touch that the New York Fed $29 bn loan and the JPMorgan Chase subordinated $1 bn note will be made to a Delaware limited liability company established for the purpose of holding the Bear Stearns assets. Special purpose vehicles and other off-balance sheet entities were part of the syndrome that brought us the current mess. It’s therefore charming to see the New York Fed bestow the tax payers’ largesse through such a construct.
Just to round off a great start to a new day, checking this morning on the NY Fed web site, I found that it remains the case that the collateral offered at the Term Securities Lending Facility (lending Treasury securities against collateral to Primary Dealers) will be valued daily by the clearing bank acting as the agent for the Primary Dealer. This is the same cockamamie approach to valuation as was agreed for the Primary Dealer Credit Facility (PDCF), the new arrangement under which Primary Dealers can borrow overnight from the Fed’s discount window. If ever an arrangement was designed for Primary Dealers and their clearers to collude to pass off pig’s ear assets as silk purse collateral to the Fed, this is it.
Time for a tax payer class action suit?
The Fed is hiring BlackRock to deal with BS!!!
Posted by: fh | March 25th, 2008 at 4:02 pm | Report this commentWell, whaddya Fink of that?
Dear Mr Buiter,
This is a question on the big picture, since the Reagan/Thatcher era free markets with the guide of a lightly regulated financial market has been seen as the best way to run an economy but with the current financial meltdown that we are witnessing what do you think will happen after as you suggested the central banks start purchasing the risky assets outright to get rid of the systematic risk in the financial markets. With both the communist/ socialist planning of the economy and the unregulated free market knows best ideologies looking discredited what will be the solution and the next direction. I know that competitive and free markets in an economy have produced extraordinarily things over 200 years and will probably be the dominant system throughout our existence but perhaps the financial system needs to be reformed and what this crises has proved as you have pointed out is that the growth in transactional based banking and the creation of another shadowy banking world has shown to be unstable.
I would be interested in your views on the big picture going forward after this crisis.
Posted by: Guled G | March 25th, 2008 at 5:03 pm | Report this commentYour swift grasp of key points in this Bear non-market is enviable.
J.P. Morgan
In previous crises over the last century and more, J.P. Morgan’s recipe for appearing as the White Knight (and profiting from the crisis) has been to have cash when others don’t. Levering that cash 30 to 1 on the Federal Reserve in context of a crisis caused by high leverage ratios is an elegant display of chutzpah!
Bear Stearns
Is $8 per share much moral hazard? If the management and/or Board collect termination payments, that would seem to me a much more seriously hazardous event.
The Taxpayers
The short term purpose of accepting this collateral seems to be to put the best face on some bail outs. I just hope that someone in the Fed has slipped in an armour-plated small print clause insisting with penalties that when things have settled down all funds loaned to entities that are still solvent must be repaid quickly in full, principal and interest; and giving the Fed clear claims on all assets in case of insolvency ahead of management and shareholders.
The “Big Picture”
Posted by: David Heigham | March 25th, 2008 at 6:36 pm | Report this commentWas not borrowing short and lending long (i.e banking) always a risky activity?
I keep on getting amazed at how much power the Fed has. As long as it can come up with a (or any ridiculous) excuse, which will sooner or later be proved as lies, the Fed can stick the bar tabs to the tax payer, no questions asked. And the tax payers are just so powerless, and made look like fools and laughing stocks.
Hi, how about a new Cadillac for my 1990 oldsmobile? I can list a lot of better reasons.
Posted by: Andy Sun | March 25th, 2008 at 8:00 pm | Report this commentHere is the question that the Fed will ultimately have to answer for: If the Fed withdrew its offer to lend, shares in Bear would become worthless and the firm would fold. How is it possible then, that the Fed has been forced into retreat by saber-rattling from a few shareholders, when doing so not only undermines whatever moral-hazard benefits the rescue might otherwise have scored, but, by raising questions about the Fed’s stewardship of US taxpayer’s money, might ultimately trigger a backlash the undermines the case for Central Bank independence.The Fed must become sensitive to the importance that its actions be perceived as fair by the voters. As daunting a task as containing the current financial crisis appears to be, there is more at stake than rescuing Bear and mortgage bonds.
Posted by: Daniel J Aronoff | March 26th, 2008 at 12:30 am | Report this commentThe Fed is trying to save a sinking ship. The only question now is will the ship take down the Fed with it. The more risk that is assumed by the Fed, the more “cockamamie approaches” we will witness. Once again, the Fed is only buying time as it can not fight the power of gravity.
Posted by: Doug Wolkon - Author of The New Game | March 26th, 2008 at 4:42 am | Report this commentI don’t think that there is any moral hazard concern for shareholders. Shareholders are buying equity in a company, and it is in their best interests that the company’s long-term outlook be bright, so that the value of their shares rises.
Posted by: Nick N. | March 26th, 2008 at 7:19 am | Report this commentThe moral hazard we are confronted with is the ability of bankers to make large sums of money by taking high risk strategies, and the big paydays that come with success, without suffering the consequences of the inevitable failure (borne by the shareholders).
We are told that we are now in the position where allowing the banks to become victims of their own aggressive risk taking and incompetence will mean terrible penalties for everyone. One can understand this, but it seems taxpayers are going to pay in full for the close to fraudulent behaviour of the bankers, while they keep the wealth they have not created but creamed off.
Saving the economy is one thing. But who is going to make those culpable pay?, as they should - heavily. Many financial experts (so called) believe anything more than light regulation should be avoided. If this is where light regulation has got us, let us tighten it enough to prevent the ruinous excesses of the last 10 years in future.
Posted by: David | March 26th, 2008 at 10:45 am | Report this commentJPM is a Fed member bank. Thus, the Fed will help them out. This whole Bear Stearns deal almost seems more about helping JPM grow it’s
Posted by: joe smith | March 26th, 2008 at 2:36 pm | Report this commentassets than helping the country. It’s big fish eat the little fish and the fed is throwing little fishes into the big fish’s mouth.
The strategy of the major banks and other big financial institutions in this self-inflicted, persistent credit crisis is painfully obvious - they just keep hoarding the cash to cover their own ‘amoral’, culpable posteriors, thereby deepening the crisis and obliging a sycophant Fed to run to the rescue of the present ‘amoral’ financial order, all on the tax payers’ dime. And The Strategy is working. Get ready to welcome a general, massive bail-out. The moral of the story? A drowning financial/economic superpower will grab at almost anything tossed its way, even the massive lead balloon of a morally bankrupt market-wide tax payer rescue, in order to keep its head above water for a few more moments.
Posted by: W. Joseph Stroupe | March 26th, 2008 at 6:27 pm | Report this commentThe complete disregard of the taxpayers’ interests by the Bush government, and the taxpayers’ quiescence (so far), is astonishing. The Fed has socialized the risk and allowed the profits that should be the reward for taking the risk (that $8/share) to remain private. Bernanke and Paulson have much to answer for.
Posted by: Nari N. | March 26th, 2008 at 10:53 pm | Report this commentThe announcement by the Senate Finance Committee Chairman Senator Richard Grassley that his committee is opening a full scale investigation in the Bear Stearns/Fed fiasco confirms for many people what they had suspected all along :the decision to bail out Bear Stearns was a POLITICAL decision,not economic.There is no justification to provide public funds to bail out a group of overpayed,wealthy and politically well-connected thieves,when millions of homeowners are losing theit homes without any kind of government support!What is even more strange is that NONE of the Presidential candidates has taken any kind of stand on this issue.Comments anyone????
Posted by: raymonda | March 27th, 2008 at 4:01 pm | Report this commentHow about “Inflation here we come.” Is anyone keeping track of how much money is being printed for the wars and emergency subsidies such as this one?
Posted by: Chris, Little Rock, AR | March 27th, 2008 at 9:06 pm | Report this commentIs EVERYONE missing the main point?
Posted by: John | March 29th, 2008 at 9:28 pm | Report this commentJP Morgan is sweetening the deal because it wants to do so. It wants to hire and retain the minority of Bear Stearns staff whom it believes are worth keeping; most of these are shareholders, because Bear Stearns assumed that they (and several others) were worth keeping. They will be more willing to work for JPM if it seems to be friendly. Offering $2 and later raising it to $10 is much more encouraging to employee-shareholders than starting at $40 and reducing it to $10.
Please do not imagine that I am a fan of Bear Stearns but parts of it make disgusting profits so they are worth a lot of money to another bank.