Did the Fed's Move Prevent a Stock Market Panic? 24 comments
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Willem Buiter explains today why he thinks the Bear bailout was unwarranted. I apologise for quoting at some length, but believe me, it's a lot shorter than the 2,150-word blog entry:
While the Fed, like any public institution, should support institutions and arrangements with public goods properties, like markets, it should not as a rule support private businesses, even when these private businesses are misleadingly called financial institutions. The Fed should support individual businesses only if failing to do so threatens serious negative externalities. In the financial field these externalities often are through contagion effects, as in the case of the classical bank run by depositors...
Deposit-taking institutions are deemed to fall into this category because they are an important part of the retail payment mechanism. Other institutions are deemed too systemically important to fail because they play a key role in the wholesale payments, clearing and settlement system.
Finally, some institutions are provided with liquidity on non-market terms or bailed out when they are insolvent because it is feared that their failure would trigger a chain-reaction of contagion effects. Fear and panic would spread through the markets and first illiquidity and then insolvency would threaten institutions that would have remained both solvent and liquid but for the failure of this 'focal institution'.
How does Bear Stearns line up according to these three criteria for special Fed attention? Bear is not a deposit-taking institution. It plays no role in the retail payment mechanism and is of no significance to the proper functioning of the wholesale payments, clearing and settlement system...
Since Bear Stearns is not a deposit-taking institution, and appears to be of no other systemic significance, there is no need for a special resolution regime of the kind managed by the FDIC for troubled deposit-taking institutions. The firm could have been left to go into receivership.
If the Fed fears the risk of contagion effects and financial panic, it could have requested the nationalisation of the investment bank. This should have been done at a zero price. The existing shareholders could, if the US government were feeling generous, be granted the privilige of claim on whatever value is left after all other creditors have been paid off.
While I have a certain amount of sympathy for this tough-love approach to the banking system, in the end I'm quite glad that Ben Bernanke and Tim Geither, softies that they are, went down the route that they did. Not because I think Bear's shareholders deserve their $30 per share or whatever they're going to end up receiving, but rather because of the sheer amount of wealth that could have been wiped off the stock and bond markets as a result.
It turns out, you see, that every mom-and-pop stock-market investor is actually, and rather unwittingly, taking investment-bank default risk. Which is why it's nice to have a Fed on the lookout for them. So far, retail stock-market investors haven't panicked; let's try and keep it that way, shall we?
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This article has 24 comments:
I have to disagree with your assessment. While I appreciate the sentiment regarding shareholders of Bear, nice employees that I have known, and your belief that market participants (the average retail investor) are taking i.b risk by being in the game, I firmly believe that the Fed's move will have the following results;
1) The Fed's move gave the US taxpayer more exposure to the i.b community than we already had. As you infer, we had exposure by being in the market, now we're the recourse backer of JPM's benevolent move to buttress BSC.
2) The Fed's move simply put us on the hook for BSC's part - (in a sense nationalized them) and then put the rest of the market on watch signaling that things must really be bad. Now we have a weekend to have investors freak out more and watch the blood bath on Monday.
3) I believe the move gave shorts more of an opportunity to get shorter and set up when the markets took off early.
4) The Fed sets up a terrible precedent that any bank that gets in trouble will be worthy of saving. (large bank, not community bank)
5) Each move the Fed has made will and has made things worse later. Each move to pump liquidity in the system drives the dollar lower, oil higher and commodities higher, will make inflation that much nastier. More rate cuts won't make banks lend when Bear's example shows us that they will only enhance their balance sheet. Tuesday's rate cut will only continue this troubling trend.
5) 10x, 20x, or 30x leverage sounds neat, but as we've seen will get you into trouble when things don't go perfectly. About the only thing the Fed can and should do is reign in margin requirements. The bottom line is that the Bear is now the US Taxpayers mess and we'll still have to endure the market meltdown as we test lows. Unfortunately, the Fed is good intentioned (like we all are), but the Fed essentially added to our market exposure by giving me 1:150,000,000 of their bailout. (assuming their are 150 million taxpayers).
YES -- WHY DIDN'T THE S&P BREAK THROUGH 1270?
NEVER, EVER, UNDER ESTIMATE AMERICA.
IF WANT PROOF, JUST READ SOME OF OUR HISTORY.
May Bear rest in peace.
Then hedge funds will move into commodities to further tax the people with "inflation."
Meanwhile, the government will use taxpayer dollars to keep they're friends on life support in the public interest while investment banks unload depreciating private mortgage-backed debt securities like they're magical collateral assets in a clear case of alchemy.
Although a BSC insolvency notice would have engendered a domino series of margin calls to the hedge funds associated with BSC, the time-delaying save only slows the market downturn momentum giving the hedge funds more time to quietly deleverage away from equities. Funds of funds will get out to lock in 5 years' worth of profits, and only taxpayers will be left with crippled 401k's denominated in devalued dollars when the market crash finally arrives... it's admittedly a very smart economic system for a few.
The market will wind down to the same place, although they're just using taxpayer dollars with term-auction facilities and devaluing the dollar with rate cuts to give hedge funds more time to comfortably deleverage. Would you prefer another espresso, Sir?
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but hey Wall Street has always been about "smart" guys relieving dumb guys of their money and it appears it always will be.
There should be a risk to the CEO for failure. Right now I do not see one. This may be part of the problem.
Here's an update - The Fed has intervened at least one time a month creating new facilities to provide liquidity and clean up rotten balance sheets. As we all know, it has been way more than once a month, which hardly indicates occasional interference.
While my posts sound like I want the world to melt down and punish all that is far from the truth. My point here is simply that yes, the Fed potentially avoided an all out slaughter Friday, but the reality is that it set us up for a slow blood-letting for what I think will be the next several months.
The Fed's action did this by prolonging the big wash out we need.
The Fed’s action does nothing about the real cause of the hedge funds and Bear’s blow up. The continued acceleration of late mortgage payments and foreclosures will be the fuel for much more of the collateral devaluation of the “structured weapons of mass destruction”. As I see it, the move by the Fed simply moves the obligations of BS to JPM and you and me. What part of the Fed’s move today did anything to stop the melt down in these deals? More foreclosures will simply cause further write downs on these and other banks will slip down the same slope as Bear. I’m sure we’ll bail them out too.
Just look at the Canadian ABCP program. Government stepped in and now it looks like a complete disaster rather than freezing it and selling it off at a much higher recovery rate. Now I suspect that investors will receive 10 or 15 cents on the dollar (Canadian dollar that is). Government action while well meaning is distorting what an efficient market will do ---- reward the winners and take the losers out to the woodshed and beat them up.
This is not over and when the Fed continues to put its head in the sand and assume that printing money and providing liquidity will solve all the problems in our world, we continue down an inflationary slippery slope that will punish us all. Watch out for higher oil, food, and metals costs.
What's interesting to me is that C has been very quiet and they were the one that I've been watching most.
You think that's coincidence?
03/14 10:30 am VOLUME 74.55M AVG VOL 22.51M SPY
The question isn't, do you want to have corrections or not, the real question do you prefer lots of little isolated corrections, or one all consuming collapse that threatens the very system which enabled it.