RSS feedI was away this week as the news came out about the Bear Stearn’s bail out buy out. There’s been a ton written on the subject already, but I thought I’d collect a few of the best pieces out there and throw my two cents in. Many pundits seem up in arms that the Fed has opened the discount window to investment banks and prime brokerages. If you listen to presidential candidate Ron Paul, the new Term Securities Lending Facilities (TSLF) which essentially trades dollars for mortgage backed securities is has completely undermined the buying power of the U.S. dollar. Now, we see the first openly apparent bail out of a firm in the deal negotiated between Bear Stearns and J.P. Morgan with ample assistance by the Federal Reserve.
I don’t deny that we have entered uncharted territories with these new actions by the Fed. Businessweek termed recent moves by the Fed as “historic,” noting that even the best economists cannot predict exactly what impact the TSLF and changes in policy for the discount window will provide in the long term. What we do know is that over the last 6 months, cuts to the Fed funds rate and discount window have done little to mitigate the effects of the recent credit crunch.
In the end, will it be the tax payers and general American populous who pay the price for the poor choices made by a small number of investment banks? No one really knows what these mortgage backed securities are truly worth and the Fed has essentially created a “dollar standard” for them by guaranteeing the ability to swap them for treasury bonds. After all is said and done, it could be the Fed which is left paying the bill on these securities. What does this even mean? To be honest, I’m not quite sure myself. If the Fed loses money, does it just create more money?
No the path from here on out is not clear cut and easy, but what must be acknowledged is that actions such as these were necessary. With markets already on the brink with the burst of the housing bubble and subsequent bursting of the mortgage backed securities bubble, credit markets were tight as is. Bear Stearns sat as one of the largest prime brokerages in the market with their hands in almost all of the money exchanging hands between hedge funds and other institutions. No one can even begin to imagine the ramification of freezing all of Bear Stearns assets had they been allowed to go bankrupt. The entire financial system as we know it would be torpedo-ed. We would be looking at depression level ramifications.
J.P. Morgan and Bear Stearns and other investment banks are not being “protected” by the Fed here. No matter what pundits are saying about the Fed swooping in to save rich people from their own blunders. Bear Stearns is more than 30% owned by employees. Their life savings will be wiped out by this deal and more than half of them will lose their jobs entirely. At first glance, it may seem that J.P. Morgan is getting a huge deal here. Everyone and their mothers have been pointing to the fact that the Bear Stearns office building is worth over a billion dollars as is. But, let’s not forget that in order to keep the Bear Stearns ship afloat, J.P. Morgan will be taking a $6 billion write down in order to provide liquidity. This is why they are only able to pay $236 million up front. I implore you to find me another buyer with the ability to take such a huge write down, provide liquidity, and pay a premium in excess of $236 million all while continuing to support Bear Stearns’ clients without a hitch.
In the end, these actions, however controversial, were necessary to avoid a catastrophic event and there isn’t a person in the world who should decry them. It may turn out that they are just a band aid as opposed to a permanent fix, but with the economy teetering on the brink, we need all the time we can buy. If you’re interested in reading even more about the macroeconomic ramifications of the credit crisis and the Fed’s response to it, check out this page at Investor Insights presented by John Mauldin.
