Friday, March 21, 2008

Did The Fed Push Bear Into a Bad Deal?

DealJournal -, March 21, 2008:
There are a lot of things that look right in the heat of the moment, and highly problematic in hindsight. Is J.P. Morgan’s proposed takeover of Bear Stearns one of those things?
The Fed did not learn how bad Bear’s condition was until Bear and the SEC told the Fed late Thursday March 13, and at that point, the firm said it saw little option other than to file for bankruptcy by Friday morning. The Fed pushed Bear to find a private sector buyer before markets opened Friday, but Bear couldn’t. At 7 a.m. Friday the Fed, for the first time in its 95 year history, approved a direct loan to Bear, a step so extraordinary it required the use of two special loopholes in the Federal Reserve Act. The Fed’s priority wasn’t to minimize losses for Bear shareholders but to prevent uncertainty over Bear’s fate from causing the derivative and repo markets to dry up, which meant finding a buyer if at all possible before Monday. That you knew already; and if you didn’t, you can find the whole timeline here.
See all of Deal Journal’s posts on the fall of Bear Stearns. Plus, click here for continuing coverage from the Wall Street Journal.
Still, that’s cold comfort for shareholders. “We thought they gave us 28 days. Then they gave us 24 hours,” one person familiar with Bear told the Journal. J.P. Morgan’s deal for Bear Stearns has several unusual features that make the deal particularly favorable to J.P. Morgan and comes at the expense of Bear Stearns’s shareholders, who are losing billions on the $2.40 a share offer. It’s nearly impossible for any rival bidder to break it up, J.P. Morgan already has management oversight of Bear, J.P. Morgan can buy the building even if Bear’s board rejects the deal, and J.P. Morgan can buy up to 20% of Bear’s shares if any other buyer does the same. So in essence, the Fed didn’t just support a deal, it supported this deal, with this buyer, and anyone who doesn’t like the terms of the deal is naturally going to start dusting the Fed and Treasury for fingerprints. What might have looked like a bailout and rescue last week to many now looks like highway robbery to some.
There’s a big element of Monday-morning quarterbacking in the complaints about the deal. Remember where the regulator stood before the sale: As late as the morning of Wednesday, March 12, Bear CEO Alan Schwartz was on CNBC saying the firm’s liquidity was fine. Bear didn’t tell the Fed and the SEC that the firm was in trouble until 7:30 p.m on Thursday March 13, and at that point, the firm was threatening to file for bankruptcy by Friday morning. The Fed tried to find a private sector buyer Thursday night, but couldn’t. If Bear filed for bankruptcy, its counterparties could potentially panic and destroy the $4.5 trillion repo securities market, and potentially touch off massacres in the credit-default swaps market, too.

Wednesday, March 19, 2008

Financial crisis and the real economy

Corporate DealMaker, March 19, 2008:
At times of financial turmoil there's something reassuring about the term "the real economy." It would be even more reassuring if it didn't usually denote a realm threatened by forces emanating from a scary parallel universe. But when the headlines describe large, familiar financial institutions gravely damaged by securities so complex that nobody can put a price on them, it's nice to recall that there's a world out there where people are still making tractors. Let's just hope it can be kept safe from the reckless and greedy denizens of Wall Street.Lots of us think this way. Isn't the ongoing surge in commodity prices partly a revolt against weird abstractions? Forget those freaky collateralized loan obligations and, while you're at it, the U.S. dollar they rode in on. Give us some gold and oil and steel and coffee. In fact, I would be betting really big on commodities right now, except for one thing. I'm actually a little worried that commodities are forming a bubble of their own. You see, the wizards down the hall from the ones who designed those CLOs have continued to improve on the futures and options originally created so producers and users of commodities could manage price volatility. Now exchange-traded notes and other nifty new instruments may be facilitating investment flows way out of proportion to the actual demand for commodities. Well. As the great soul singer Tyrone Davis said of a situation like the one poor Mrs. Spitzer recently faced, there it is. The tensions in the often stormy, centuries-old marriage between finance and industry, between Wall Street and Main Street, have flared up once again, and there seems little doubt about who deserves the blame. Until we start the couples therapy.That's when things get messy. The conversation can't ignore people who are needlessly losing their homes and good businesses that can't get capital. Our patchwork system of regulating financial institutions obviously needs updating, and it's not just securities but also reputations that are being marked to market. It's already happening to former Fed chairman Alan Greenspan, and also to Robert Rubin. The former Clinton treasury secretary received more than $100 million as chairman of the executive committee at Citigroup over the last eight years, even as the nation's biggest financial institution helped to dig the hole we're now in. But we will do well to remember there's a relationship worth salvaging here. On one hand, Rubin arrived at Citigroup after he and Greenspan helped to remove the regulatory barriers to the merger that created it. Now it's falling to their successors to improvise some new guardrails. Another hallmark of the Greenspan-Rubin 1990s, though, was the financial diplomacy that helped turn developing economies into emerging markets for tractor-makers and then, when that project devolved into another great financial crisis, got it back on track. If either of these men wish, like Tyrone Davis, that they could turn back the hands of time on a few decisions, they haven't said so. Certainly other people in the financial world would like to. But they can't, and neither can those of us who identify more closely with the so-called real economy. We'll just have to try and make sure we get more of what we need out of the relationship in the future.--Kenneth Klee

Link to Professor's Klee's Biography:

Monday, March 17, 2008

Subprime Crisis: The PWG Weighs In Blog, Broc Romanek and Dave Lynn, March 17, 2008:

Subprime Crisis: The PWG Weighs In
Last week, the President's Working Group on Financial Markets issued a Policy Statement on Financial Market Developments, reflecting the collective views of the Treasury, the Federal Reserve, the SEC and the CFTC on how to deal with the current market turmoil.
The report does not appear to break any new ground in describing the underlying causes of the problems: sloppy mortgage underwriting; the "erosion of discipline" in the securitization process, including failures to provide adequate risk disclosure; flaws in the credit rating process; and weaknesses in risk management and failures in banking policies to mitigate those weaknesses. The recommendations in the report might best be characterized as a suggestive – and perhaps soft – in terms of getting at these identified issues. Much of what is suggested could take years to implement – such as getting all states to implement nationwide licensing standards for mortgage brokers (if all states need to do it might not a federal licensing standard be a better idea?), compelling institutional investors to seek better risk information and better ways to evaluate risk other than through credit ratings, reforming the credit rating process, and enhancing risk management practices and prudential regulatory policies for financial institutions.
The one issue that the report actively sidesteps is what sort of concrete steps must taken with respect to the enormous OTC derivatives market that remains the 800-pound (or maybe $500 trillion) gorilla in the room. It has been the common wisdom that regulators need to continue to steer clear of the OTC derivatives market, lest they snuff out the flames of financial innovation that everyone loves until someone (or everyone) gets burned. Now we have a north of $500 trillion in notional amount market that has virtually no oversight – other than industry "oversight" – and no way to get a handle on the systemic risks posed to the worldwide financial system. Instead of suggesting any radical reforms, the PWG says that financial institution regulators should insist that the industry promptly "set ambitious standards for accuracy and timeliness of trade data submissions and the timeliness of resolutions of trade matching errors for OTC derivatives," urge the industry to amend credit derivative documentation to provide for cash settlement in the event of a credit event and ask the industry for a long terms plan for developing an integrated operational infrastructure. Whoa, some tough words on derivatives from the PWG!

The Bear Stearns Bailout: Is this the Big One?
Almost as if to underscore that the suggested fixes in the PWG report aren't going to do anything to alleviate the current state of locked-up credit markets and rapidly deteriorating asset values, news began to break early Friday about the need for a Federal Reserve lifeline to the venerable Bear Stearns. The SEC put out this press release on Friday, noting that it was monitoring Bear's capital adequacy in the light of the firm's rapidly eroding liquidity. In a conference call on Friday – memorialized in this real time blog of the call – Bear Stearns executives said that the ability to borrow against the firm's collateral from the Fed through JP Morgan was going to give them a chance to look at strategic alternatives – although they apparently weren't thinking at the time that filing for bankruptcy or selling the firm at a fire sale price within 48 hours were among those alternatives.
As noted in this article from today's WSJ, JP Morgan has agreed to purchase Bear Stearns for $236 million or $2 a share – quite a delta from the firm's market value of $3.5 billion on Friday. The Bear Stearns board was apparently cajoled by government officials, who indicated that they might not be able to bail the firm out if it did not do a deal before markets opened again this week. Shareholders interests were of little concern, it seems, as the firm's insolvency became imminent when counterparties continued to refuse to do business with Bear and prime brokerage customers ran for the exits. Apparently the Fed's credit line on Friday was not enough to stave off the "run on the bank."
The WSJ article notes that financial regulators are "scrambling to come up with new tools because the old ones aren't suited for this 21st-century crisis, in which financial innovation has rendered many institutions not 'too big too fail,' but 'too interconnected to be allowed to fail suddenly.'" Not too comforting by any stretch of the imagination.

Thursday, March 06, 2008

Hedge Funds Frozen Shut

Business Week Online, March 5, 2008:

To buy time and stave off losses, more funds are blocking withdrawals. Are they just postponing the inevitable?
by Matthew Goldstein

There's a chill spreading across the hedge fund industry. With more portfolios falling victim to the credit crunch, managers by the dozen are freezing investor redemptions, preventing a mad rush to the exits that would force funds to sell beaten-down assets to raise cash. But is this unprece­dented move just postponing the day of reckoning for funds and the market?
Since November at least 24 hedge funds have barred or limited investors from taking their money out, tying up tens of billions of dollars for an indefinite period.
It's understandable why hedge funds would want to keep investors from pulling out their money en masse. In this market, any sales would almost certainly be at cut-rate prices, guaranteeing big losses in portfolios. And once managers start dumping assets, there's also the danger that big banks, which provided the funds with credit lines to amp up returns through what's known as leverage, will demand their money back as collateral shrinks. Those margin calls would prompt further sales, setting off a vicious cycle that could ensure a fund's demise.

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