Fed Action's Too Late to Save Bear Stearns

I’m starting to get the sense that U.S. Federal Reserve Chairman Ben Bernanke’s job is harder than any of us can comprehend.

And a component of that Triple Black Diamond difficulty comes in the need for people in his position to have a sense of what problems are coming down the pike, and getting ahead of them.

Last fall, “Helicopter” Ben was chastised by many market observers for missing the signs in the weakening subprime mortgage market. Mr. Bernanke’s critics are going to have a field day after last week.

On Monday morning, rumors about liquidity issues at Bear Stearns (BSC) became very insistent (see prior post “Bear rumor speaks volumes,“ March 10, 2008). Despite having made the rounds for the prior couple of weeks, with little impact on the stock, the rumor seemed different this time. Bear’s shares started to crumple, falling 13% in the first 150 minutes of the trading day, and speculators were buying C$58 dollar puts even though BSC was trading in the mid-C$60s. Unusually out-of-the-money.

Around midday on Monday, Bear Stearns boss Alan Greenberg called in to CNBC to say the rumors (posted here, thanks to a great tip, before Bloomberg and Reuters filed their initial stories; back pat) “were ridiculous.”

Not true.

The very people that provide credit to each other hundreds of times a day - the banks and brokerage firms - knew what they knew. Clearly, many of them were starting to get less comfortable advancing sums to BSC as of Monday. And perhaps Bear Stearns was no longer providing as much leverage to its “prime brokerage” clients as it had been in prior weeks. With less cash on hand, Bear wouldn’t be as able to provide as much credit to its hedge fund Dark-Arts clients. Who better to ascertain the financial health of a business than the customers and counterparties?

These are but two of the many ways the Bear rumor might have been started, and I’m pretty sure - in hindsight - that it wasn’t a “rumor.”

It was a tremor. Like those hints you get from the tectonic plates shortly before a large earthquake is about to happen.

In an effort to help shore up firms such as Bear Stearns, on Tuesday, the U.S. Federal Reserve announced (undermining Mr. Greenberg’s earlier protestations), that it would now accept AAA mortgage-backed securities as collateral. This move was clearly designed to help Bear Stearns, the #2 U.S. underwriter of mortgage-backed securities, among other large independents (think Lehman Brothers (LEH)).

Here’s one take on the move by the CIBC World Markets’ Economics & Strategy Department:

Last Tuesday’s surprise Fed announcement that it would set up a new securities lending program to trade Treasuries for select mortgage-backed securities was greeted enthusiastically by financial markets. But despite the initial high hopes of investors, this measure, like the ones before it, will not be a cure-all. It will not fix the underlying credit issues that gave birth to the current financial crisis, nor will it keep home prices from continuing to fall, and it is unlikely to keep real GDP growth from sliding into negative territory during the first half of the year.

This latest creative policy action by the Fed is not intended to be a substitute for further monetary easing over the next few months. Rather, it is designed to help ensure that rate cuts translate into lower effective borrowing costs for banks’ customers. Just as the Fed’s mid-December decision to temporarily set up a Term Auction Facility was largely motivated by the desire to control term borrowing costs for deposit-taking institutions, this latest Fed initiative is designed to help securities dealers boost the liquidity of their MBS holdings in order to increase their lending capacity.

In the end, this was too little, too late.

The news of the $200 billion Term Auction facility drove North American financial shares higher on Tuesday, and Bear Stears recovered almost C$6 of its Monday swoon. But, it didn’t last.

The very firms that do business with Bear didn’t change their view between Monday and Wednesday, and the ducks began to quack once again. By Thursday, the very reasons why the financial community had been starting to pull back their counterparty risk from Bear Stearns took hold. Overnight, the Federal Reserve stepped in, using J.P. Morgan (JPM) (with assets of $1.6 trillion) as the funding conduit.

The moral is this. When it comes to financial stocks, there are no secrets (see prior post “‘Panic’ sets in to the debt markets,“ July 29, 2007). If a business is in trouble, it is very hard to hide it from the folks across the street. The industry is just too intertwined.

The very people yakking about funding issues at Bear Stearns were the very ones who should have known there was trouble brewing - they are, after all, the people that trade with them all day. If they were nervous, it didn’t take a leap of faith to expect them to calm their own nerves…and yank the funding relationships.

The Fed underestimated the subprime crisis. Now it has raced unto the scene on its white horse, only to find out that market confidence in Bear Stearns may well be past the point of propping up. It’s not as though the signs weren’t there. As a result, a sale of BSC over this weekend is not out of the question.

One thing’s for sure. Helicopter Ben’s critics will be at it again tomorrow.

Comments

[notsosmart]

all these bold faced lies undermines the whole system. i dont believe the ceo's & other top management anymore on anything. ethics is gone. sadly this is true when things are good & the market is rising the only difference is nobody cares whats said.

[GeorgeFarrell,The AngryBlack Man'sGuide toSuccess]

Open Markets or Welfare

On Tuesday, March 11, 2008, the most remarkable transfer payment from the Federal Government to Corporate America occurred. The United States Federal Reserve, operating through the Federal Open Market Committee and in response to a deep and severe credit crisis on Wall Street, developed a very unusual plan to exchange United State Treasury Bonds for AAA Mortgage Backed Securities. Because of this blatant market manipulation, Wall Street responded with a 400-point rally.

In my book "The Angry Black Man's Guide to Success," I state that one of the rules is to being successful is understanding that "People do not do what they have to do, they do what they want to do." In the same vein, the Fed did not do what they have to do, but what they wanted to do. Instead of doing what they have to do, maintain free and open markets, let Wall Street firms and hedge firms take the fall for investing in mortgage backed securities, and let the stock market continue a freefall that started on Friday, March 7, 2008 of more than 250 points, the Fed interfered in free markets by exchanging Treasury bonds for securities of very little value.

Let me break it down. Let’s say you have a General Motors automobile that you paid and financed for $30,000.00 for in March 2007, and the vehicle depreciated to $25,000.00 by March 2008, but your loan balance remained $29,500.00. Car salesman generally refers to this as being upside down. Well, GM sees that you are having trouble making the payments and wants to help and therefore they offer to exchange your payment booklet for $30,000.00 in GM stock that you can then pledge or sell and still keep the car. WOW! What a deal. You can trade a liability for an asset. The Fed is acting like a pusher and Wall Street is responding like an addict, sniffing up all the coke in the room.

Wall Street celebrated but those of us who truly believe in capitalism see a very sad day. First, hedge funds and investors will only see this as a way to take quick profits, liquidity will not return to the market, and the Stock Market will continue its steep decline through the second quarter. Its not Wall Street that will stop this recession, but consumer confidence. I believe the Fed should continue to cut rates but not interfere in open markets. Like a junkie, Wall Street will pull back until the Fed provides the next hit.

So, how will angry men and women, black and white, take advantage of this falling market with a weak dollar? Simple, if you play the market, follow the Fed.

[Tyrone]

George: Your comments are so timely and correct. I use options to time the market. Up when the Fed makes a heavy handed move to stop a natural market decline and short when the Fed is silent. I think the Bernake and the Fed is making it worse. Plus Greenberg at Bear Stearns is walking with 350 mil for trashing the company. I am going to buy your book. Mark, you need to find this guy.

[GeorgeFarrell]

Tyrone:
Just visit my Blog to find out more at abmgts.blogspot.com Wait until asian investors figure out that the Federal Funds discount window is additional credit and not capital. Thats the second shoe