Bear Stearns Roundup
A couple of years ago, I had dinner with an investment banker who had gone to Chicago a few years before I did. He spent a great deal of the time extolling the virtues of modern markets, proclaiming that over the last ten years, we'd become massively better at pricing risk.
Being a great fan of John Kenneth Galbraith's work on asset-price bubbles, I felt the hair go up on the back of my neck. "Are we really better at it?" I asked. "Or do we just think we are?"
"No, we're really better," he assured me. Ooops.
The subprime problem has its roots in pro-business government intervention; the policies at fault were designed to help the housing industry and the lenders who write mortgages. Now the other shoe is falling. Big lenders and investors handling securitized mortgages who are in over their heads will get their promised bailout under the "too big to fail" doctrine. And the rescue will set the table for the next round of bad business decisions and the next bailout. It's called moral hazard.
What does this have to do with the free market? As Kevin Carson likes to say, if this is the free market, then I'm against it. Of course, it is not the free market. The free market is a profit and loss system void of privilege. When businesses fail, they are supposed to actually fail, not turn to the taxpayers.
Market purists gasped when the British government nationalized mortgage lender Northern Rock last month. But how would you describe tonight's Bear Stearns bailout? It wears the costume of a market transaction. JP Morgan is "buying" Bear for $2 a share. But the Federal Reserve is taking the unprecedented step of seizing control of Bear's investment portfolio. And it is giving JP Morgan Chase a $30 billion loan to take Bear over. So the Fed is simultaneously financing the deal and managing the workout. Why not end the charade and hand Ben Bernanke the keys?
Federal Reserve officials twisted J P Morgan's arms -- which was why the latter 'agreed' to buy. Officials had to provide Morgan's with a loan & a guarantee against the weakest 'investments' -- bad mortgages -- in the Bear Stearns portfolio. These dubious liabilities amount to some $US 33,000 million -- or some 138% of its total purchase price. Thus its unsound investments are one reason for the very very low price that Bear Stearns' shareholders received -- even from J P Morgan's & even after a Federal loan + guarantee.
In the absence of Federal Reserve intervention & arm-twisting, Bear Stearns would undoubtedly have had to cease trading. And no doubt it would've been taken over, eventually -- at an even lower price. All that govt officials could do was to shorten this time period, & possibly prevent Bear Stearns' value from falling even further. But even the almighty Federal Reserve -- the world's largest & most powerful central bank -- could not prevent the huge capital losses that Bear Stearns' shareholders suffered. In short, even the Fed could not stop the de facto failure of one of the world's largest investment companies.
