Implications of the Bear Stearns Bailout

Everyone needs some time away, but those of us in the investment world never really get it. Managing money carries with it the responsibility of monitoring information and staying in touch, no matter how talented the team on the front line.

We are talking with a lot of individual investors. The doom and gloom is palpable. It is no surprise that the viewpoints reflect the themes of the popular press and websites. We plan to return to the broad themes, but let us take Friday's news as a case in point.

CPI Data

For a few minutes Friday morning the market celebrated the news that February CPI (seasonally adjusted) was unchanged. The data critics were warming up. How could gasoline prices be down? (Answer: Look at a chart. This is February data, compared with January. People are already thinking March).

There is a reason why those who are not economists and have never actually collected or analyzed data are so critical. If no one believes the official data, they are free to propagate any argument based upon anecdotal evidence. With the cost of living, it is easy to point to items that have increased in price, ignoring any serious methodology or balance.

Bear Stearns (BSC)

The story, as we now know it, seems to be that Bear suddenly and unexpectedly experienced a broad scale loss of accounts. Since financial institutions do not and cannot keep enough cash around to meet all redemptions, this "run on the bank" carried a systemic risk. Counter-parties of Bear might also fail. Forced selling (yet another round) of illiquid assets would partly meet obligations, but might force another round of write-offs by other institutions.

In a couple of weeks, Bear would have been able to use the new Fed TLAF facility for this collateral, but could not do so yet. Bear turned to its banker, J.P Morgan (JPM) and described the situation. JP Morgan could borrow from the Fed's discount window, but did not want to have the traditional "stigma" that comes with such actions. The Fed agreed to backstop their action, leaving JP Morgan with no exposure.

What to Conclude

Explained in this way it seems like a success story. Something that was completely unexpected created a major threat. The parties involved acted swiftly and effectively. While stock market traders aggressively sold financial issues, the major system threats were averted.

To realize this, ask what would have happened if Bear indicated insolvency with no support from the Fed.....

Some Comments from the Punditry

Bear lied. [How do we know this? The "later" story was that rumors became a self-fulfilling prophecy.]

Bear caused the problem when the CEO went on CNBC to explain that "all was well." Multiple pundits and traders explained that this was alarming and caused the problem. [A key feature of a successful CNBC interview is to show how smart you were about something that already happened. Let's hear from those who caught this contemporaneously.]

The Fed has lost all credibility, according to a featured trader on CNBC. This is because of "what they said about interest rates." [These trader comments are amazing. The Fed acted much more rapidly than past Feds in similar historical situations. They adjusted policy rapidly with new data. We wonder if traders would prefer a situation where the Fed did not respond to data?]

Everyone in power is an idiot. [Our view is that the Fed has been aggressive and creative. Bernanke has acted more swiftly than past Fed chairs, and has also used creative means. The TAF facility was disparaged by pundits at the launch, but was actually quite successful.]

We cannot trust anyone. [This is the ultimate argument for pundits. If the average investor cannot trust statements by the Fed, by any CEO, or by the government, then it is open season for those promulgating fear. Fear sells.]

Conclusion

A top financial analyst came up to me Friday and stated that no one was bullish. Everyone he talked to shared the view that all of the government officials were stupid, the data were manipulated, the recession would be severe, technical support had been violated, and the market might crash. Everyone.

The dilemma. So many are saying that the market has given a verdict. If one thinks that the market is always right, in the short term, then there is no edge for the investor or the fund manager.

Comments

[User 86999]

"... If no one believes the official data, they are free to propagate any argument based upon anecdotal evidence. With the cost of living, it is easy to point to items that have increased in price, ignoring any serious methodology ..."

Anecdotal evidence? Try empirical evidence from the previous cpi announcements and then the revised numbers. Calculate the degree of correction (upon correction) to find the evidence.

A serious methodology? Any serious methodology reflects the facts not the academic jugglery with the numbers and philosophy.

But then again, I suppose you get paid to create material like this to sweep the ugly stuff under the rug! Keep skimming the poor guy until he bleeds. Good luck to you (not really).

[sammyg123]

Mr. Miller, it is ignorant to just skip over prices on the front lines of life, like gasoline, milk, flour, eggs - all of these things are rising every month. CPI data collection discipline is flawed and lags badly. It's just a fact. Commodities prices, across the board, don't lie. Inflation is here, regardless of the CPI. The question is, what will the Fed do after it's done saving the pigs like Bear Stearns, as if BSC is the last shoe to drop? How will they be able to dig us out of inflation? It's going to be painful. That's what the stock market is trying to price in right now, along with whatever financial implosion happens next. Reality bites, but it is best to stick with it.

That being said, rallies will happen as we grind lower. Bulls and bears eat, but Pig Bear Stearns is slaughtered. I shed no tears for them. It's their own damn fault.

[GKM]

People have been playing the contrarian card all the way down. Guess what. In a bear market, the tendency is to get oversold before a pullback just as it is to get overbought in a bull market. That doesn't change the direction.

The Fed covered the market's face with a kleenex. That doesn't change the fact the market has caught a cold. That is the real "broad theme".

[Jeff]

Sammy -- I think that "ignorance" is rather a strong word under the circumstances. I started studying inflation measure in the 70's, when I worked on the issue of indexing the Wisconsin Tax code for inflation.

Most of those in government - especially Congress -- would prefer to give more benefits to social security recipients. The decisions regarding the measurement of CPI were hammered out by a bipartisan group, mostly influenced by the GOP. I suggest a little more study of the facts. You could start by going to my blog and doing a search for the relevant source material.

In any case, the Fed policy viewpoint is pretty clear. Investors can choose to learn from what they are doing, or sit on the sidelines. They are strongly addressing the economic and credit issues. When those are under control, rates will move higher -- perhaps swiftly.

I know that you are stating what many believe. How confident are you in your sources? Will your investments profit from following them?

We shall see...

Jeff