This bail out occurred to prevent (or forestall) a general collapse of the U.S. financial market.

New York Times, Business,  March 16, 2008

http://www.nytimes.com/2008/03/16/business/16gret.html?_r=2&ref=business&oref=slogin&oref=slogin

Rescue Me: A Fed Bailout Crosses a Line

By Gretchen Morgenson, 3/16/8

WHAT are the consequences of a world in which regulators rescue even the financial institutions whose recklessness and greed helped create the titanic credit mess we are in? Will the consequences be an even weaker currency, rampant inflation, a continuation of the slow bleed that we have witnessed at banks and brokerage firms for the past year?  Or all of the above?

Stick around, because we’ll soon find out. And it’s not going to be pretty.   Agreeing to guarantee a 28-day credit line to Bear Stearn, by way of JPMorgan Chase, the Federal Reserve Bank of New York conceded last Friday that no sizable firm with a book of mortgage securities or loans out to mortgage issuers could be allowed to fail right now. It was the most explicit sign yet of the Fed’s “Rescues ‘R’ Us” doctrine that already helped to force the marriage of Bank of America and Countrywide.

But why save Bear Stearns? The beneficiary of this bailout, remember, has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach. Until regulators came along in 1996, Bear Stearns was happy to provide its balance sheet and imprimatur to bucket-shop brokerages like Stratton Oakmont and A. R. Baron, clearing dubious stock trades.   And as one of the biggest players in the mortgage securities business on Wall Street, Bear provided munificent lines of credit to public-spirited subprime lenders like New Century (now bankrupt). It is also the owner of EMC Mortgage Servicing, one of the most aggressive subprime mortgage servicers out there.

Bear’s default rates on so-called Alt-A mortgages that it underwrote also indicates that its lending practices were especially lax during the real estate boom. As of February, according to Bloomberg data, 15 percent of these loans in its underwritten securities were delinquent by more than 60 days or in foreclosure. That compares with an industry average of 8.4 percent.

Let’s not forget that Bear Stearns lost billions for its clients last summer, when two hedge funds investing heavily in mortgage securities collapsed. And the firm tried to dump toxic mortgage securities it held in its own vaults onto the public last summer in an initial public offering of a financial company called Everquest Financial. Thankfully, that deal never got done.   Recall, too, that back in 1998, when the Long Term Capital Management hedge fund required a Fed-arranged bailout, Bear Stearns refused to join the rescue effort. Jimmy Cayne, then chief executive at the firm, told the Fed to take a hike.  And so, Bear Stearns, a firm that some say is this decade’s version of Drexel Burnham Lambert, the anything-goes, 1980s junk-bond shop dominated by Michael Milken, is rescued. Almost two decades ago, Drexel was left to die.  Bear Stearns and Drexel have a lot in common. And yet their differing outcomes offer proof that we are in a very different and scarier place than in the late 1980s.

“Why not set an example of Bear Stearns, the guys who have this record of dog-eat-dog, we’re brass knuckles, we’re tough?” asked William A. Fleckenstein, president of Fleckenstein Capital in Issaquah, Wash., and co-author with Fred Sheehan of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.” “This is the perfect time to set an example, but they are not interested in setting an example. We are Bailout Nation.”

And so we are. After years of never allowing any of our financial institutions to fail, they have become so enormous that nobody will be allowed to sink beneath the waves; otherwise, a tsunami would swamp the hedge funds, banks and other brokerage firms that remain afloat.  If Bear Stearns failed, for example, it would result in a wholesale dumping of mortgage securities and other assets onto a market that is frozen and where buyers are in hiding. This fire sale would force surviving institutions carrying the same types of securities on their books to mark down their positions, generating more margin calls and creating more failures.   As of last Nov. 30, Bear Stearns had on its books approximately $46 billion of mortgages, mortgage-backed and asset-backed securities. Jettisoning such a portfolio onto a mortgage market that is not operative would, it is plain to see, be a disaster.

But, who knows what those mortgages are really worth? According to Bear Stearns’s annual report, $29 billion of them were valued using computer models “derived from” or “supported by” some kind of observable market data. The value of the remaining $17 billion is an estimate based on “internally developed models or methodologies utilizing significant inputs that are generally less readily observable.”  In other words, your guess is as good as mine.

To some degree, what happened at Bear, of course, was a classic run on the bank — the kind immortalized in Frank Capra’s homage to financial responsibility, “It’s a Wonderful Life.” As fears about Bear’s financial position heightened, its customers began demanding their cash and big hedge funds that were using the firm as an administrative back office or lender moved their accounts elsewhere.  In addition, institutions that had bought credit default swaps from Bear Stearns, insurance policies that protect against corporate bond defaults, were scrambling to undo those trades as the firm’s ability to pay the claims looked dicier.

“For the government to print money at the expense of taxpayers as opposed to requiring or going about a receivership and wind-down of any insolvent institutions should be troubling to taxpayers and regulators alike,” said Josh Rosner, an analyst at Graham Fisher & Company and an expert on mortgage securities. “The Fed has now crossed the line in a very clear way on ‘moral hazard,’ because they have opened the door to the view that they are required to save almost any institution through non-recourse loans — except the government doesn’t have the money and it destroys the U.S.’s reputation as the broadest, deepest, most transparent and properly regulated capital market in the world.”

And here is the unfortunate refrain.  Investors, already mistrusting many corporate and government leaders, were once again assured that nothing was wrong — right up until the very end. So is it any wonder investors react to every market rumor of an impending failure with the certainty that it’s true? In too many cases, the rumors turned out to be true, notwithstanding the attempts at reassurance by executives and policy makers. Only last Monday, for example, Bear put out a press release saying, “there is absolutely no truth to the rumors of liquidity problems that circulated today in the market.” The next day, Christopher Cox, the chairman of the Securities and Exchange Commission, said he was comfortable that the major Wall Street firms were resting on satisfactory “capital cushions.”   Three days later, it was bailout time for Bear.

HERE is the bind the Fed is in: Like the boy who puts his finger in the dike to keep sea water from pouring in, the Fed finds that new leaks keep emerging. Regulators must do whatever they can to keep the markets open and operating, and much of that relies upon the confidence of investors. But by offering to backstop firms like Bear, who were the very architects of their own — and the market’s — current problems, overseers like the Fed undermine a little bit more of that confidence.

Another worry? How many well-capitalized institutions remain at the ready to take over those firms that may encounter turbulence in the future? Banks just do not have the capital that is needed to rescue troubled firms.   That will leave the taxpayer, alas, as usual.

On the Bear Stearns Situation

From $20 Billion to 236 Million

Hale “Bonddad” Stewart, 3/17/08

http://www.huffingtonpost.com/hale-stewart/on-the-bear-stearns-situa_b_91842.html

Pushed to the brink of collapse by the mortgage crisis, Bear Stearns Cos. agreed -- after prodding by the federal government -- to be sold to J.P. Morgan Chase & Co. for the fire-sale price of $2 a share in stock, or about $236 million.

Bear Stearns had a stock-market value of about $3.5 billion as of Friday -- and was worth $20 billion in January 2007. But the crisis of confidence that swept the firm and fueled a customer exodus in recent days left Bear Stearns with a horrible choice: sell the firm -- at any price -- to a big bank willing to assume its trading obligations or file for. "At the end of the day, what Bear Stearns was looking at was either taking $2 a share or going bust," said one person involved in the negotiations. "Those were the only options."

To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns's less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn't describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.

...

Former Treasury Secretary Robert Rubin last week described the situation as "uncharted waters," a view echoed privately by top government officials. Those officials have been 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."

Let's make some observations:

-- For all practical purposes, Bear Stearns is bankrupt. Despite the shotgun nature of the Bear/JP Morgan deal, Bear would not have agreed to a $2/share valuation unless the damage to their business was extremely severe.

-- JPM swooped in quickly on this deal. My guess is they have been watching this situation for some time and waited for the right moment to get this deal. All the players lined up too quickly in JPM's favor for this to be a happy coincidence. JPM sees a play here and went for it. This actually is good news. If there are other firms in financial straights right now, others know about it. The Fed has demonstrated they will help to finance the deal. In short, if another firm goes bankrupt it will be a quick procedure to deal with it.

-- The Federal Reserve is scared shitless. There is no reason for them to get involved in this deal unless they were worried about one of two things (and probably both): 1.) the ripple effect and/or 2.) other banks in a similar situation. The Fed is looking for any tool (and making some new ones up) to prevent a system wide crisis.

-- Last week S&P announced the end of the writedowns at the big banks was near an end. Almost on cue, events demonstrated how hapless S&P has become when it comes to credit analysis.

To combat further problems, the Fed has lowered the discount rate and expanded its credit facilities.: 

The Federal Reserve, struggling to prevent a meltdown in financial markets, cut the rate on direct loans to banks and became lender of last resort to the biggest dealers in U.S. government bonds.

In its first weekend emergency action in almost three decades, the central bank lowered the so-called discount rate by a quarter of a percentage point to 3.25 percent. The Fed also will lend to the 20 firms that buy Treasury securities directly from it. In a further step, the Fed will provide up to $30 billion to JPMorgan Chase & Co. to help it finance the purchase of Bear Stearns Cos. after a run on Wall Street's fifth-largest securities firm.

``It is a serious extension of putting the Federal Reserve's balance sheet in harm's way,'' said Vincent Reinhart, former director of the Division of Monetary Affairs at the Fed and now a scholar at the American Enterprise Institute in Washington. ``That's got to tell you the economy is in a pretty precarious state.''

The move is Chairman Ben S. Bernanke's latest step to alleviate a seven-month credit squeeze that's probably pushed the U.S. into a recession. The dollar tumbled to a 12-year low against the yen and Treasury notes rallied as traders increased bets that officials will reduce their main rate by 1 percentage point when they meet tomorrow.

`Race to the Bottom'

``Clearly, the Fed is trying to provide more liquidity to prevent a more vicious cycle and race to the bottom,'' said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, which oversees $200 billion. ``The problem is there's so much concern about credit quality that now there are solvency issues, and it's something the Fed has a more difficult time dealing with.''

 I was listening to Bloomberg this morning and someone commented that Bernanke is a student of the great depression and that knowledge was serving him well. I agree with that sentiment. I have made a great deal of fun at Bernanke's expense over the past few months. Frankly, I feel a great deal of empathy for him because he is between a rock and hard place.

However, I understand his reasoning for taking these moves. Simply put, Bernanke is trying to prevent a financial sector meltdown.

The central problem the Fed faces right now is their tools are not designed for the problems we face. What we have right now is a collateral and counter-party crisis. That means two things.

1.) The collateral crisis means that collateral on bank's balance sheets isn't performing as well as advertised. Basically, any bond backed by mortgages is in trouble because homeowners aren't paying their mortgages. That means banks who hold mortgages aren't getting the payments they should be getting. As a result, banks balance sheets -- which serve as the basis for their ability to extend credit -- are in serious trouble. That means...

2.) Anyone who might take out a loan might not pay it back. This is called counter-party risk. It simply means that everyone is at risk of defaulting on a loan right now. That means loans aren't getting made. In an economy like the US economy where credit is a prerequisite to everything, that is the kiss of death.

The Fed can provide plenty of money. Over the last 9 months they have flooded the market with cash. But that does not good if people aren't willing to use it. And right now, no one wants to loan anybody any money. That's the central problem -- and so long as that exists there will be a mis-match between the Fed's policy tools and the market's problems.

Let's look to the future: 

This week Bear, Goldman Sachs (GS), Lehman Brothers (LEH) and Morgan Stanley (MS) are slated to report results for their first quarter, ended in February. The results won't be pretty.

The new name on everybody's lips is Lehman Brothers:

Lehman Brothers Holdings Inc. Monday said the bank's liquidity position remains strong, as the fire sale of Bear Stearns to J.P. Morgan to prevent bankruptcy increased speculation that other big U.S. brokerages would come under pressure.

"Our liquidity position is and continues to be strong," said Matthew Russell, head of corporate communications for Lehman Brothers Asia Pacific.

His statement came after people familiar with the situation said DBS Group Holdings, Southeast Asia's biggest bank by market capitalization, has asked several traders not to enter new transactions with Lehman Brothers.

"DBS has sent an internal e-mail saying it would not deal with Lehman Brothers from now on. It said DBS shouldn't enter into new dealings with Lehman or Bear Stearns," one person said. Another person said that the email didn't mention anything about closing existing positions with Lehman, which appear to remain in place for now.

DBS's move follows the near-collapse of Bear Stearns Cos. Friday, a similar pullback by counterparties caused the bank's liquidity to dry up. J.P. Morgan Chase & Co. Monday agreed to buy Bear Stearns for $2 a share in a bid to avert a bankruptcy by the U.S. investment bank

Since the middle of August, when the collapse of U.S. subprime mortgages started to infect markets around the world. Since then, the S&P 500 stocks index has dropped 11 percent and the dollar has fallen 15 percent against the euro.

The central bank on March 11 announced it will for the first time lend Treasuries in exchange for debt that includes mortgage-backed securities held by dealers to facilitate market- making. It holds about $713 billion of Treasuries on its balance sheet.

On March 7, the Fed said it would make $100 billion available through repurchase agreements, where the Fed loans cash in return for assets including mortgage debt issued by Fannie Mae and Freddie Mac.

Must watch:

Parts of Europe (such ask Netherlands and Denmark) use small local electricity generation plants, which permits the use of the byproduct heat for heating.  In one example they use all he CO2 generated to supply 4,000 hectares of green houses.   The combined heating and energy production (CHP) is a proven technology that lowers the energy consumption for electricty and heating by over 50%.   British (BBC) documentary on this http://www.youtube.com/watch?v=klooRS-Jjyo&mode=related&search

Teddy Roosevelt's advice that, "We must drive the special interests out of politics. The citizens of the United States must effectively control the mighty commercial forces which they have themselves called into being. There can be no effective control of corporations while their political activity remains."