JP Morgan buys Bear Stearns for $2/share. This is fantastic news. One, JP Morgan picked up Bear’s financial obligations, so they believe they can be met, and we don’t get a default that really could trigger a broader financial panic. Two, there’s no government bailout, at least not in this case. Bear fucked up, and they’re paying for it. This is is how financial markets are supposed to work: If you take on too much risk, or evaluate risk incorrectly, you may get burned, and Bear did.
The Buck Stops Where?: If you want to be a pessimist, the way that the Fed is cheapening the dollar is the best argument that our immediate economic future is dim. We’ve seen scattered reports in the last two weeks that the recession is already abating and that economic growth should resume in the next quarter, so why is the Fed still pushing interest rates down? This would be a good time for President Bush to step in and show the sort of economic leadership he showed earlier in his tenure when he pushed for lower marginal tax rates, elimination of the dividend tax (albeit temporarily), and freer trade. The editorial argues that the Bush administration has tacitly approved of Bernanke’s rate cuts, and if that’s true, it’s a huge mistake. A weak dollar will drive investment funds out of the country at a time when we need more coming in to help ease the credit crunch. This is one example where the equity markets have it wrong. The Fed needs to start bumping rates back up, and sooner rather than later.
Not entirely true on “no government bailout” part Keith.
“The Federal Reserve and the U.S. government swiftly approved the all-stock buyout to complete the deal before world markets opened. The Fed also essentially made the takeover risk-free by saying it would guarantee up to $30 billion of the troubled mortgage and other assets that got the nation’s fifth-largest investment bank into trouble.”
This was basically a risk free investment by Chase, backed by the government.
That’s not a bailout. You’re right that I overstated the case, but a bailout would have meant the feds assuming those obligations. If we get through this credit crunch without the government actually taking on any obligations from overstretched banks, that’s a win in my book.
Lower interest rates creates malinvestment and inflation? No way!!!
-George Bush and Ben Bernanke
“We’ve seen scattered reports in the last two weeks that the recession is already abating and that economic growth should resume in the next quarter, so why is the Fed still pushing interest rates down?”
Technically. we’re not in a recession, are we? There’s been no official NBER declaration. Since people are quibbling over whether we’re in one or not, how can you see signs that we’re coming out of one? In the last quarter of 2007, GDP growth slowed considerably, to less than 1%. Even so, the economy has not actually contracted since a short period in 2001 and there is still a debate about whether it will this year. According to the Anderson Forecast by the University of California at Los Angeles, released last week, overall growth in 2008 will be 1.5%.
Paul Krugman sees a tax payer financed bailout in the future:
http://www.nytimes.com/2008/03/17/opinion/17krugman.html
One of these days Paul Krugman will be right about something…
Regarding the bailout – it is one Keith, no matter how you slice it. Hank Paulson has said as much.
The Fed is taking on the less-liquid securities that have near-zilch value in today’s panic-driven markets as collateral. Now it may be that in a more .. calm environment, these securities are worth more, but its a de facto $30B insurance policy. Its especially absurd when you consider that the Bear’s entire mortgage book was $33B and sub-prime was $2B. You can see in the market’s reaction – JP’s market value went up to 8%. Dollars to donuts, some of the $30B guarantee will end up subsidizing JP’s own toxics.
Dola,
I don’t see the arguement that its not a bailout. The government has given JP an insurance policy. JP may not end up using the policy, but that doesn’t detract from the value of the policy now. Essentially, its a put option on $30B worth of assets – that has value today.
We’re getting into semantics here, but it’s like guaranteed contracts in baseball and basketball, right? You get more guys dogging it in those sports or eating themselves out of the league than you do in football, right?
Poor analogy, but you catch my drift.
The really insane thing about this whole story to me is that 14 months ago Bear was trading at over $150 a share. Last Friday it was down to $30/share, and on Sunday they agreed to be bought for an all-stock deal at $2/share, equivalent to about $236million. Now, the actual cost to JP is going to be a much higher multitude of that considering the costs of merging operations and workforce downsizing, but the insane thing is that Bear’s Madison Avenue headquarters, recently completed by the famous (if not particularly adventerous) firm Skidmore, Owings, & Merill, is worth approximately $1.2 billion, which presumably will now be in the hands of JP Morgan. I think that just goes to show you how scary the liabilities that Bear has on its books must be, for such a discount to be paid. Hopefully JP can use the trading floors in that building so they don’t have to build a shadow-inducing cantilever at their Ground Zero site.
Also, I’m just questioning Keith’s comment that “Bear fucked up, they’re paying for it.” Not 100% sure about that. Are Greenberg & Cayne going to be paying for it? Sure, their options have lost value, but Cayne just a couple of days before the meltdown purchases an almost $30 million pied-a-terre at the Plaza. They aren’t going to hurt that badly; it’s the lower-level employees, some of whom are partly responsible, surely, who will lose their jobs, and who collectively own about a third of Bear stock, that are going to be hurting. And employees of JP who will lose their jobs as part of consolidation, as well. Remember when Enron went bust; working folk were the ones who paid the biggest price, and they destroyed Andersen Consulting in the process.
“This is one example where the equity markets have it wrong. The Fed needs to start bumping rates back up, and sooner rather than later. ”
I agree that rates need to be pushed up for the good of the economy, but I have trouble agreeing that the equity markets have it “wrong”. Lower rates are good for the equity markets — but what’s good for the equity markets and good for the economy are not always the same….
Andersen Consulting was spun off as Accenture pre-Enron. It destroyed Arthur Andersen.
Jeff — thanks for catching that slip!
“One, JP Morgan picked up Bear’s financial obligations, so they believe they can be met, and we don’t get a default that really could trigger a broader financial panic. Two, there’s no government bailout, at least not in this case. Bear fucked up, and they’re paying for it. This is is how financial markets are supposed to work: If you take on too much risk, or evaluate risk incorrectly, you may get burned, and Bear did.
”
Keith, I don’t see how either point is true if the government is guaranteeing the assets. JP Morgan doesn’t necessarily believe the obligations can be met. The risk was taken away by the government so they’re in a “why not?” situation.
Bear CEO Alan Schwartz said in a televised interview on Wednesday that the company does not see any pressure on its liquidity and had about $17 billion in excess cash on its balance sheet. That was in the NYT this morning.
So either he is a friggin moron, or he should be going to jail soon. There has to be so much more to this story that we haven’t heard about yet.
Guys, the government isn’t guaranteeing the assets. The $30B is facilitating the deal to move some subprime MBS off the balance sheet for a while to avoid unwinding countless other positions. The associated contagion would be “impressive.”
There is a reason why 1) the deal was done in 36 hours and 2) the price was 5% of Friday’s closing and agreed to by BSC. This is a full-fledged crisis supported by the fact that the Fed cut rates on the discount window another 25 bps a day before its scheduled FOMC meeting in which rates are expected to be cut another 100 bps.
JPM took on substantial risk. However, BSC reduced much of the risk by “giving” JPM the keys to their house. The gov’t intervention greased the wheels, but BSC and JPM did the heavy lifting here. BSC made serious concessions to avoid 1) bankruptcy and 2) widespread global financial panic.
There is much here we won’t ever see. But what we are seeing is a lot of panic which should be telling.
Malcolm – what are you talking about? Keith’s assertion is spot on. Did you see what happened to Bear on Friday? Their liquidity constraints were quite transparent because they made horrible bets. And considering that Cayne and Greenberg major stockholders of BSC, these guys lost more in one weekend than most of us will make in a lifetime. You sure that Cayne is going to close on that pied a terre? I’m pretty sure some of his lines of credit aren’t too liquid right about now.
Keith –
I agree with you regarding the weak dollar. But remember, Bush has been a strong proponent for pushing for a weaker dollar thanks to Schumer & Graham in the Senate.
The more the Fed cuts, the more the dollar weakens, the more investors flee, and the bigger the credit/asset deflation issue becomes. The thing with the Fed is that they have one bullet. The housing crisis is creaming Bernanke’s rep and if he doesn’t have the confidence of the markets and America what use is he? Remember, this is a guy who spent his entire career studying economic crises. He’s running through his playbook – cut, cut, cut.
It would be very nice of Congress to give Bernanke some room by 1) cutting marginal tax rates permanently, 2) cutting cap gains taxes, 3) cut business tax rates. This would increase corporate profitability, improve homeowner affordability, and give Bernanke the space to stabilize the dollar.
Francis — of course Cayne et al are losing money; that wasn’t my point. My contention was that the biggest losers in this mess are going to be lower-level employees of Bear Stearns. Much of their benefits and retirement income is in the form of Bear stock, which right now is the price of a subway ride in NYC. Who is going to hurt more: the billioaire who loses 75% of their net worth, or someone making six figures (admittedly, still a handsome sum), who loses 75% of their net worth. Those percentages are arbitrary, of course, but my point is that the people who hurt most aren’t always the ones who are calling the shots.
As a guy living on the dollar in Brazil, I’m with Keith. I’m getting killed here.
Malcolm,
I love your class-warfare talk. However, economic theory tells me that the little guy actually loses more because Cayne and the other bigwigs lost so much wealth. Via the wealth effect, and considering that 75% of $1B is much greater than 75% of $100K, the consumption lost from Cayne and the associated effects are much more substantial here. Also think of the tax write-offs that the bigwigs now have. All those government programs with less funding now…
But the real issue is that if the employees and equity holders of Bear didn’t go down, everyone else would have. And I literally mean everyone as in the global economy.
To every malady under heaven the WSJ editorial page prescribes tax cuts. The world is always going to hell in a handbasket unless WE GET A TAX CUT. Keith, increasing interest rates now would devastate the economy as it would increase the price of the dollar and decrease exports, our only out because consumer consumption, which was driven on the back of mortgage equity withdrawals, is drying up. The economy has not been lacking investment money, on the contrary, the country was awash in liquidity looking for investment opportunity for several years. The only weapon Bernanke has is to let the dollar crumble, driving down everyone’s standard of living, but at least boosting the export economy.
With the Canadien dollar worth more than its American counterpart, I wonder if the Nationals regret leaving Montreal. And perhaps the Blue Jays will gross more than the Red Sox and Yankees. And Keith, when you worked for the Jays, were you paid in American or Canadien currency?
The above post isn’t meant to be taken seriously.
“Two, there’s no government bailout, at least not in this case”
Not exactly true. The Fed worked REALLY hard to see to it that this deal happened. James Dimon just happens to be on the FRB board, the federal reserve is desperate to avoid further liquidity problems and JP Morgan makes a deal that will almost certainly make them a killing.
“A weak dollar will drive investment funds out of the country at a time when we need more coming in to help ease the credit crunch.”
Huh? A weak dollar brings foreign investment funds into the country as those with stronger currency look to pick up bargains in the country.
“This would be a good time for President Bush to step in and show the sort of economic leadership he showed earlier in his tenure when he pushed for lower marginal tax rates”
Since when does white house approval or disapproval mean a thing when it comes to what the FOMC does? Long term stability requires an independent and apolitical central bank. Hopefully Bush is smart enough to remember that.
“We’ve seen scattered reports in the last two weeks that the recession is already abating and that economic growth should resume in the next quarter,”
Maybe. Or maybe we are just waiting for the rest of the bad paper to mature and cause another round of bank closures deepening the liquidity crisis. The worse of the bad mortgages dont reset until january 09 I believe.
Interesting article, acknowledging that the source of our trouble is the liquidity crunch and then arguing against low interest rates because it leads to a weak dollar.
(1) Aside from the cost of energy a weak dollar is not inherently bad. It can drive exports and bring in foreign investment, two good things in a recession.
(2) If one were to look for the primary cause of the weak dollar the first culprit would not be interest rates, it would be the budget deficit and debt.
(3) I find it FASCINATING that the article is clearly upset about a weak dollar but lavishes praise on the tax cuts which (when combined with excessive government spending) cause the weak dollar in the first place.
(4) No one acknowledges that the real source of the current troubles was a result of weak regulatory action and oversight of the mortgage industry, combined with the criminal oversight by Bernanke to keep track of wall streets CDS shell game. His preference for academics and contrived models over hard data street knowledge got us here.
A weak dollar sends investment funds abroad in search of higher returns. The pool of investment capital depends on savings accounts, money market accounts, and the bond market. Those returns are all dampened by lower interest rates.
Cuts in the top marginal tax rates lead to increased government revenues. This was true of the ’01 cuts, the Reagan cuts of ’82, the JFK cuts, and the Harding cuts in the early ’20s. The argument that tax cuts lead to the weak dollar is incorrect and unsupported by any bit of economic history.
“Cuts in the top marginal tax rates lead to increased government revenues. This was true of the ‘01 cuts, the Reagan cuts of ‘82, the JFK cuts, and the Harding cuts in the early ’20s. The argument that tax cuts lead to the weak dollar is incorrect and unsupported by any bit of economic history.”
Ack. That’s debatable even using dynamic scoring…
“A weak dollar sends investment funds abroad in search of higher returns.”
Or it brings in foreign money in search of bargains, increases manufacturing exports and the consumption of domestically produced goods.
“The pool of investment capital depends on savings accounts, money market accounts, and the bond market. Those returns are all dampened by lower interest rates.”
Or it can increase the amount of investment capital available by making loans cheap and leverage easy. Given that GS leverages 40 billion into over a trillion dollars I would say that the effect of cheap money is greater then that of 4% versus 3% on your savings book.
“The argument that tax cuts lead to the weak dollar is incorrect and unsupported by any bit of economic history.”
You mis-characterize my argument. I did not say that tax cuts alone caused a weak dollar, I said that tax cuts “when combined with excessive government spending” (ie large government debt) caused a weak dollar.
However I don’t think you or anyone else can establish a causal link between the tax cuts and higher government returns. Far too many factors in the mix and if it was true I believe someone could have quantified it beyond some lines on a napkin.
Phill-
Tax cuts + excessive govt. spending causes a weak dollar? How so?