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Chicken
Suppose that Monday morning, Ben Bernanke is presented with a deal, under which a buyer gets Bear assets on the cheap, Bear stockholders get paid out, and the Fed (implicitly or explicitly) bears residual risk. If the Fed doesn't approve, executives say, Bear will file for bankruptcy. Dr. Bernanke will then have an unappetizing choice. He can say yes, and hope that there aren't any more rumors out there about any other firms. Or he can say no, and make it very clear that if Bear Stearns files for bankruptcy despite the Fed's continuing provision of liquidity, he will do everything in his power to hold Bear executives personally responsible for the crisis that results.
Who do you think has more bargaining power in this game? The firm with the reputation for obnoxiousness and recklessness, or a charming, intelligent and indeed gentlemanly central banker? We may know soon enough. Here is more, and here, and don't forget this. Here is a news report, if you are interested in the background.
Update: Seems to be a deal...at about $2 a share. Book value of about $80 a share.
Posted by Tyler Cowen on March 16, 2008 at 06:32 PM in Current Affairs | Permalink
Comments
The Fed should just announce that in the event of Bear Stearn's bankruptcy, they'll stand behind all of Bear's unmet obligations. That would (1) allow the Bear equity holders to lose everything and allow Bear to be wound down and (2) keep the financial system from flying apart.
Posted by: enplaned at Mar 16, 2008 7:12:40 PM
Looks like this just got outdated within an hour...
http://news.yahoo.com/s/ap/20080316/ap_on_bi_ge/jpmorgan_bear_stearns_11
Posted by: Joey at Mar 16, 2008 7:48:12 PM
enplaned,
Pretty close. The shareholders get $2/share.
Posted by: Bernard Yomtov at Mar 16, 2008 7:53:18 PM
Bernake was presented with this scenario Friday night.
Posted by: mickslam at Mar 16, 2008 7:54:39 PM
Accept the Bear Sterns deal at $2 a share, and cut the discount rate one quarter of a point at the same time. As a friend at the FDIC told me last November, its game on!
Posted by: Dennis Delay at Mar 16, 2008 8:13:04 PM
The Fed takes first $30B in risk. If these "difficult to price securities" are all mortgage related, take a look at the markit on the ABX securities site to see that the $30B headline number is worth at most $15B and more likely about $6B if marked to market, and less if they actually try to sell them.
Posted by: mickslam at Mar 16, 2008 9:02:10 PM
1. What 'personal responsibility' do the execs need, other than
the fall of the stock price from $150 a year ago to $2 today? Bear's ex CEO Cayne was a billionare in January, and is worth less than 10 million today, before counting debts and the legal fees that he'll surely be paying.
2. how much risk does the Fed actually bear? JPM has assumed Bear's counterparty risk, which is the part that matters for the financial system. Does the Fed only bear the risk that JPM too fails? They (or more accurately taxpayers) already bore that risk, as a JPM failure would be well in the N-word range.
IMHO being bought out for $2 is a bankruptcy in all but name. The $2 is presumably a premium for not facing bondholder lawsuits and bankruptcy court costs as well as shareholder lawsuits. It's hard for me to see it as a 'victory' in a game of chicken.
Posted by: DK at Mar 16, 2008 9:06:08 PM
The $2 is presumably a premium for not facing bondholder lawsuits and bankruptcy court costs
I suspect this is correct. It almost seems like a token payment, or the minimum needed to prevent BS from going into bankruptcy, which would create massive problems.
Posted by: Bernard Yomtov at Mar 16, 2008 9:17:25 PM
Tyler,
The root of the problem is Bernankes weak $ policy.
You cash in your appreciating euros for a depreciating asset(dollars) to buy another depreciating asset(US stocks), Ben has managed to shut off almost all ROW(rest of the world)investment in the US equity market.
Nice move Ben, all to help out our export market.
Stupid is as Stupid does.
Posted by: russ at Mar 16, 2008 10:30:07 PM
Tyler,
The root of the problem is Bernankes weak $ policy.
You cash in your appreciating euros for a depreciating asset(dollars) to buy another depreciating asset(US stocks), Ben has managed to shut off almost all ROW(rest of the world)investment in the US equity market.
Nice move Ben, all to help out our export market.
Stupid is as Stupid does.
Posted by: russ at Mar 16, 2008 10:30:44 PM
Short LEH premarket tomorrow around 9:00 AM.
They are next.
Wheels coming off the cart of the global financial system. . .
Posted by: Matthew at Mar 16, 2008 10:48:54 PM
Think about Tyler's comment. $80 book value, sells for $2.
Now ask yourself why you would want to own ANY financial stock with any exposure to any of these "hard to price" assets.
Read this if you wanna be scared. . . Lots of toxic waste like this on the balance sheets of lots of big financial institutions, paid for with borrowed, leveraged $$$.
Posted by: Matthew at Mar 16, 2008 11:02:53 PM
russ,
For better or worse I think that the low interest rate policy of the Fed and Bernanke
has not been directed at saving the US export market. Rather it has been directed at
lowering the costs for banks to borrow to help prop them up. It has been directed at
avoiding things like what just happened with BS. Of course it has not worked so far,
at least partly because the falling dollar is stimulating a rising price of oil, which
in turn is adding to the destabilization of the financial markets and the degradation
of assets, which has underpinned the everincreasing problems in the banking sector.
Posted by: Barkley Rosser at Mar 16, 2008 11:42:16 PM
Anybody else never even heard of Bear Stearns til a few days ago? I only started seriously studying economics last year, and finance is BOOOO-RRRING.
Posted by: Jacob Oost at Mar 16, 2008 11:47:45 PM
In terms of holding the executives at Bear accountable, a sale at $2 is a lot rougher than bankrupcy. Remember with bankrupcy the inmates still run the asylum, and hang on with "retention" bonuses etc.
Posted by: Ben A at Mar 17, 2008 12:10:57 AM
Barkley,
The low interest rate policy is because of a weakening economy, just a little while ago it was a high interest rate policy. This Fed is always behind the curve on its interest rate policy. Did the thought ever occur to you that the 17 rate hikes by Greenspan and Bernanke might have had something to do with a weakening economy.
You are of course right about the dollar and oil.
Equating oil to the destabilization of the financial markets and the degradation
of assets, is a stretch. Asset prices based on oil,WOW.
No, you avoid the Macro, the IMF in the good old days used to proscribe the cure of higher taxes and cheap money in return for loans, and a health dose of that poison is what we are getting now.
Higher taxes in 2010 and maybe even 2009, and a cheap dollar. Bernanke has the power to control the dollar by selling Bonds from its portfolio and making dollars a little more scarce. It's about time he starts doint that or it will only get worse.
Posted by: russ at Mar 17, 2008 12:17:44 AM
Barkley,
Do you agree with this:
It can decide to withdraw cash from circulation, doing so by taking the $1000 bond from its portfolio of assets and selling it on "the open market." The decision on whether or not to buy bonds to create cash or sell bonds to extinguish cash is made by the Fed's Board of Governors and the presidents of the regional Federal Reserve banks.
http://www.wanniski.com/showarticle.asp?articleid=4897
Posted by: russ at Mar 17, 2008 12:22:40 AM
At what point do the economists admit, that while they may have convincing explanations for past events, they have no freakin' clue on how economies and markets actually work in real time.
Posted by: Steven Donegal at Mar 17, 2008 12:38:24 AM
"At what point do the economists admit, that while they may have convincing explanations for past events, they have no freakin' clue on how economies and markets actually work in real time."
They -- or at least, the laissez-faire economists -- definitely have no freakin' clue on how to LEARN from past events: how many market failures have to occur before people finally get it through their heads that deregulation leads only to disaster?
Posted by: ranger_granger at Mar 17, 2008 12:54:45 AM
ranger danger, what specific regulations that were repealed led to the troubles we are in now?
See, economists deal with cause and effect solutions, principles that are derived from empirical data. Not political rhetoric. Or at least, they shouldn't.
Posted by: Jacob Oost at Mar 17, 2008 1:02:00 AM
Matthew,
A Bloomberg article has a positive take on Lehman (LEH) for the long term. For tomorrow on the other hand, you are right that they will probably take a hit.
Posted by: at Mar 17, 2008 1:02:52 AM
"ranger danger, what specific regulations that were repealed led to the troubles we are in now?"
Glass-Steagall?
Posted by: at Mar 17, 2008 1:06:37 AM
Barkley,
A little more reading.
In 1991, Minister Cavallo expressed a philosophy of social contracts in explaining his position: "Each peso is a contract between the government and the peso holder. That contract guarantees that each peso -- as a unit of value that the holder has worked hard to get -- will be worth as much tomorrow as it is today. If the government breaks that contract, it's breaking the law. The only role of the government in the economy should be to guarantee the integrity of market transactions."
http://www.polyconomics.com/searchbase/g2-10-95.htm
Posted by: russ at Mar 17, 2008 1:35:07 AM
I wanted to short LEH Friday at 42 but the trading funds won't hit my account until Tuesday.
Tried to get my work buddy to short it instead, target 30.
We could open at LEH 30 tomorrow easy. BSC equity holders just taken out and SHOT tonight! 30 to 2 over the weekend!!! Un-fricking-believable. Hope the windows are sealed shut in those trading offices who picked up BSC@30 on Friday. . .
Posted by: Matthew at Mar 17, 2008 1:40:53 AM
Maybe the fed drove a harder bargain then you expected. Bear management and shareholders wiped out.
BSC debt is rescued. That would have been a mess and maybe taken others down.
The shorts who bought CDS's don't have a credit event. The huge credit derivative market won't have to pay out on BSC.
If JPM got a great deal, then fine. They need to come out of this strong. If there was any question of them getting dragged down, then things get much uglier.
JPM gets to 'sterilize' $30 B in BSC assets. This takes care of most of their MBS and $9B in leveraged loan paper and commitments.
JPM is booking $6B in transaction costs or $50 per BSC share.
The other IB's will have access to the discount window. No reason for them to fail for liquidity reasons.
Posted by: Ziggurat at Mar 17, 2008 2:14:40 AM
