Inside the Federal Reserve's $30 Billion Bear Stearns Bailout
Let the Demagogy Begin
By blackhedd Posted in Economy — Comments (65) / Email this page » / Leave a comment »
Ask your average well-informed person what the Federal Reserve did, a week and a half ago. (By "well-informed," I mean someone who regularly reads newspapers and watches or listens to broadcast news.)
She's quite likely to tell you that the Federal Reserve expended $30 billion in taxpayer funds in order to purchase a large amount of worthless mortgage-backed securities from the Bear Stearns Companies. She may have connected enough dots to believe that JP Morgan would have refused to acquire Bear without the $30 billion lollipop.
And a lot of angry questions are probably now circling around in our well-informed average person's head. First and foremost of which is: "How on earth did $30 billion of my money get stuffed into the pockets of some gazillionaire Wall Street fatcats in the middle of the night, without so much as a vote in Congress?
I'm nothing short of amazed at the array of economics PhDs and other quite-expert people who are jumping into news interviews to create just exactly this impression. The clamor for immediate new regulations of the financial industry is already starting. And there are spillover effects too: Hillary Clinton just called for a total of $30 billion to be paid out to people who are having trouble with their mortgages. Wonder where she got that number from, considering that her previous proposal was only for a billion or two?
What's the truth of the matter? There's not enough information to fully answer the question. Let me tell you what we know for sure.
Bear Stearns unraveled so fast on March 13 and 14, that the Fed felt compelled to find a buyer for the company before financial markets in Asia opened for trading on the 17th. That meant a deal had to be made and announced by around dinnertime in New York on the 16th.
Luckily, and I really mean that, JP Morgan Chase was available. Unlike other large commercial banks, they were not in the throes of already trying to do a large acquisition, and they had a very strong balance sheet.
So over a very tense weekend of non-stop negotiating, two different and difficult things had to be done. First, deal terms had to be negotiated and drafted. (And the lawyers evidently made some wicked and significant errors, too.) Second, a minimal amount of due diligence had to be done on the assets of Bear Stearns prior to the acquisition.
I wasn't present in any of those meetings, and I've heard all the rumors and innuendo about how the negotiations went. I'm on record here at RedState before the weekend started, as believing that the acquisition value of Bear would be zero. I felt the $2/share price that eventually was agreed upon was a face-saving sop to Bear executives.
That's because by rights it should take two or three calm weeks to do a proper due diligence. Instead, Morgan had one and a half extremely tense days, over a weekend, with no prep, and with the New York Fed crawling up their anal openings the whole time.
You can't properly evaluate a portfolio under conditions like that. In Dimon's place, I would have offered zero for Bear rather than $2/share. Remember, Morgan committed to assume the obligations of an essentially-unknown portfolio that (including derivatives) had a nominal value in the trillions of dollars.
What did the Fed do to sweeten the deal?
They did not commit to take 30 billion dollars' worth of toxic waste off Morgan's hands.
What they appear to have done is to establish a limited-liability entity to take control over $30 billion worth of securities (no word yet on what the securities actually are). According to statements by the New York Fed, Morgan is responsible for $1 billion in potential losses on the $30 billion portfolio. If there are profits on the portfolio, the Fed will receive about 97% of them, and Morgan will get the rest.
I haven't yet been able to find out the answers to a range of crucial questions about this structure.
Based on fragmentary information, my guess is that the Fed formed a spinoff entity to enter into a 28-day repurchase agreement with Morgan to buy a package of securities with a face value of $30 billion.
That would be enough time to do a proper due diligence and valuation of the portfolio.
Assuming I'm right (and I have no way to tell how likely that is), after the 28 days (of which today is the ninth), the Fed's spinoff entity will resell the securities back to Morgan in return for $30 billion plus some amount of interest.
If Morgan fails to execute the repo, then the Fed's spinoff entity will go into the market and find a buyer for the paper. If that happens, they will either have a profit or a loss on the transaction.
The profit or loss will accrue to the Fed's account (not to the Treasury or the taxpayers), and they will presumably execute some offsetting transactions subsequently to "sterilize" the effect of the failed repo on the overall money supply.
Ok, I could be totally wrong about all this. I welcome any and all corrections that are based on solid information. I've been trying to reach people at the New York Fed to give me some more detail. So far, they haven't gotten back to me. If I've guessed right, however, then there has been no expenditure of public money, nor will there be.
On the other hand, this whole episode has been a golden opportunity for people who are looking for reasons for the government to take more control over Wall Street.
As I've said in other recent posts, we do need more regulation on Wall Street. But no one really knows the best way to do it yet. And it doesn't help to get misleading explanations from people who really ought to know better. They should be ashamed of themselves.
-Francis Cianfrocca ("blackhedd")