Big Banks: Too Big To Fail, Too Big To Bail

The dust remains to settle from the Federal Reserve/JP Morgan (JPM) take-over/take-out of Bear Stearns (BSC). Since the Friday March 14, 2008 meltdown we have seen wild swings. Sentiments, interest rates and market indexes have roller coastered on fear, fall-out and policy response. There is massive window dressing going on.

As the quarter and month end, losses and redemptions threaten. Pressures build and shift to trade off between winners and losers. That is the short term trading oscillation. The longer term issues involve figuring a landscape altered by the undisclosed and essential features of the Fed, bank, US Treasury policy shifts of Sunday March 17, 2008. Much of this story remains to be explained and market reaction is not terribly valuable when markets know little of what was decided. What we do know is that the Federal Reserve and leading market players have taken the next step down a slippery slope.

Ever greater policy action and market intervention have been and will continue to be in the offing. Markets have become rate easing and assistance junkies. Ever greater fixes of Fed liquidity candy are required to get markets high(er). Ultimately, we will see coordinated renegotiation of mortgage principle and or, greater government led bail/out and buy-out. The Fed and the leading market players Fed policy is unquestionably aimed at, are stuck between two competing realities.

Two swords hang over the heads of interventionist policy and deregulated speculative reality. The leading banks are too big to fail and too big to bail. The problems are too big and politically sensitive to leave to market solutions. Overt and massive interventions create many and serious problems.

The first hanging blade is sharpened by ideology and steeled by systemic risk. The second slicing instrument was forged by recent structural reality. The ideological sword involves market faith. The systemic blade has to do with how we organized the great boom (1982-2000, 2003-2007). Our financial system has prospered on massive innovation, leverage and deregulation. All three are either stalled or running in reverse. Faith and feeding frenzy drove interest and profits to new and innovative product areas. This allowed expansion of credit to American consumers and expansion of profit to financial firms. The buying of American and European consumers fueled economic development and rising incomes throughout the world. Endless cheap and easy credit allowed massive positions to be built with limited initial capital.

Leveraged home buyers provided the raw material to innovators and leveraged structured product buyers and traders. Production runs grew, commodity prices were pressured and fortunes made. Long believers could massively bid up their targets with credit and create the momentum many learned to follow. This was true of houses on Main Street, leveraged positions on Wall Street and around the world. All this required cheap leverage, tolerant regulators and faith in markets. Faith is in very low supply. If you doubt that, look at Bear Stearns and Fed actions. As for long-play feeding frenzies, they are few, far between and engineered by increasingly massive government intervention. Upswings are now created by rate cuts, bail-out/buy-out deals and waves of short covering.

Fear drives violent reallocations and flights to safety. Awareness of risk has violently re-emerged and innovation has stalled. We now face the prospect that waves of law suits and public anger will blame the instruments innovation produced for the downturn. If this occurs, we will actually run innovation in reverse. Financial neo-luddites will emerge to smash the credit innovation machine in hopes of preventing the pain that has already arrived. Leverage will be scarce, more expensive and more suspiciously viewed. If unsmoothed, this could cause rapid swings in purchasing power and price. Unwinding carry trades, deleveraging speculative balance sheets, price flip-flops loom as risks to be avoided. Leverage and innovation made new things possible and stretched returns. The deleveraging process can create losses greater than capital- Carlyle, Bear…..

The second sword is involves structural change. Our economy has lived off debt and speculation. They created a positive feedback loops and pumped leverage air into bubble positions. We evolved to benefit from and rely on this as an engine of growth. It is running in reverse now. Households and firms are in the middle stages of deleveraging. Some will get help. Others will be cold shouldered into extremis. Thus, Bear found itself crippled by a Fed cornered by the size of the task before it.

JPMorgan was assisted in helping itself to Bear's still warm remains. The surviving leaders in the investment banking space were told to help themselves to overnight cash at 2.5% interest. Life and death were determined by Fed granted access to the deleveraging medicine, cash. What was decided in those meetings seems like a new financial regulatory regime for leading Wall Street firms. The regulatory structure has been changed. Access to the discount window, greater Federal Reserve oversight, new risk modeling and lower balance sheet leverage must be in the offing for Wall Street titans? This means a different structure of financial operation is taking hold in the heart that pumps credit through the global veins of commerce.

New risks and new opportunities will take shape molded by a changed structure. New shoots will be sent out through the charred crust of the burnt out old house. This may be neither rapid nor, orderly. Thus, the second sword over market agents heads involves factoring and adjusting to a new structural environment.

Stuck between firms too large to let fail and balance sheets too large to bail, the Fed struck a balance. The New Primary Dealer Credit Facility allows investment backs to borrow overnight at 2.5% and against various illiquid securities. It is similar to the formally regulated banks' arrangement at the Discount Window but, is 1/90 the loan duration. This move into new territory suggests the Fed has changed its role in the economy. We can only assume that the present Treasury officials and President signed off on this. This is a big move. Rumors abound that formal legislation to shift capital market supervision toward the Federal Reserve and away from the SEC awaits introduction.

It looks like our financial regulatory system substantively altered in the Bear Stearns, JPMorgan meetings. There seem to be new guarantees and restrictions on our leading Investment banks? Just to help others, Goldman Sachs, Morgan Stanley, Lehman Brothers took some time off from cold calling Bear clients to visit the new candy man. They seem to be moving forward under the new order. I bet the folks at Bear wish the structural changes and new deal were opened to them? Just to test the new system for glitches, of course.

As time passes and new structures take shape, we expect there to be further bouts of rapid price oscillation, readjustment and deleveraging. It would be wise to note, the recession remains to fully arrive. We are still front running the main event and earnings season is right around the corner.

Disclosure: None

Comments

[Tie D:]

The FRB are idiots for trying to save these banks. Thank goodness for them, that the American taxpayers are bigger idiots.

The US Dollar Index traded at 76.156 less than a month ago. Due to the Feds' slash and burn policies, it was 71.198 yesterday.

That is a 6.5 percent drop in the value of all US currency. Given there is about $820 billion dollars of U.S. currency in circulation, that means that $53 billion dollars in wealth was destroyed for the sake of Lehman (a $30 billion company) and Bear, which for all intents and purposes is on life-support anyway. I don't even know where to start in calculating the loss in value of hard assets that are also valued in US Dollars.

Get ready for massive inflation, because once again, we all pay so that a greedy few large investors don't lose their assets.

Its better to stop messing with policy, and allow investors to take their medicine, than ruin an entire economy.

2008 Mar 20 08:22 AM

[hojo0710:]

I would like to buy insurance that, if I went to Las Vegas, would cover my losses and allow me to keep my gains. Isn't that what Wall Street expects, and the Fed has granted, in the current financial mess? If Bear Stearns was a weak sister, it was also a pariah, and its loss is JP Morgan's bonanza. But what else is lurking behind the veil, and who else is scurrying to patch the levee, probably in vain, before the deluge? We shall see.

2008 Mar 20 01:42 PM

[Tony Soprano:]

Since there is so much angst directed toward the Fed and the US Government, I decided to listed some events, not all of them, that had dramatic ramifications on lives, cost and the psychology of our country. I started in 1906 because it’s just a little over a hundred years. As I compiled the list, I could not help but feel the great sacrifices that many American’s have made and what a resilient country, economy and government we have in American.

The 1906 San Francisco Earthquake and fire, registered 8.25 on the Richter scale; estimates range from 700 to 3,000 dead or missing, approximately 225,000 injuries and $400,000,000 in 1906 dollars.

Recession, May 1907-June 1908, 13 mo

Recession Jan. 1910-Jan. 1912, 24 months

Completion of the Panama Canal, 1914 – 27,500 workers are estimated to have died

Recession Jan. 1913-Dec. 1914 23 months

World War I -- 116,708 killed – 33 billion

Spanish influenza, 1918, killed over 500,000 people in the worst single U.S. epidemic.

Recession Aug. 1918-March 1919 7 months

Recession Jan. 1920-July 1921, 18 months

Recession May 1923-July 1924 14 months

Recession Oct. 1926-Nov. 1927 13 months

The Great Mississippi Flood of 1927, flooded 27,000 square miles, 246 killed

The Great Depression, Black Tuesday, crop prices fell by 40 to 60 percent, after the panic of 1929, and during the first 10 months of 1930, 744 US banks failed. (In all, 9,000 banks failed during the 1930s). By 1933, depositors had lost $140 billion in deposits.

The Dirty Thirties, longest drought of 20th century. Peak periods were 1930, 1934, 1936, 1939, and 1940. The "dust bowl" covered 50 million acres in the south-central plains during the winter of 1935-1936.

Labor Day Hurricane of 1935, 400 killed

Recession May 1937-June 1938 13 months

World War II – 408,306 killed – 360 billion

Wartime Controls: 1941-1945 rationed consumer items ranging from sugar to gasoline

Recession Feb. 1945-Oct. 1945 8 months

The Marshall Plan, July 1947 – 13 billion in economic and technical assistance were given to help the recovery of the European countries

Recession Nov. 1948-Oct. 1949 11 months

Korean War, July 1951 - July 1953 – 33,000 killed in action

Recession July 1953-May 1954 10 months

Recession Aug. 1957-April 1958 8 months

Recession April 1960-Feb. 1961 10 months

The Cold War, some estimates shows $8 trillion was spent, worldwide, on nuclear and other weapons between 1945 and 1996

The Cuban Missile Crisis, Oct. 1962

Good Friday Earthquake (1964) In Alaska, it was the fourth biggest earthquake recorded

Vietnam War, 1963 – 47,378 killed in action

The murder of JFK, 1963 Nov

The Gulf of Tonkin Incident, Aug 1964

The murder of Dr King, April 1968 and Bobby Kennedy, June 1968

The city riots of April, 1968 – 30 cities affected

Hurricane Camille, Aug 1969, 259 killed

Recession Dec. 1969-Nov. 1970 11 months

Stagflation of the 1970s began

Nixon first imposed wage and price controls on August 15, 1971

Oil Embargo, Oct 1973 long gas lines

Recession Nov. 1973-March 1975 16 months

Articles of Impeachment of Nixon started
(Approved by a vote of 27-11 by the House Judiciary Committee on Saturday, July 27, 1974.)

Deregulation: 1974-1992 this era began when Nixon left office

Three Mile Island nuclear power plant crisis, March 1979

Mount St. Helens eruption 1980

Recession Jan. 1980-July 1980 6 months

Prime reached unbelievable 20% in January 1981,

AIDS was first reported June 5, 1981 by the government – It is thought that more than one million people are living with HIV in the USA and that more than half a million have died after developing AIDS.

Recession July 1981-Nov. 1982 16 months

California earthquake 1983

The 87 market crash - Black Monday

California earthquake, 1989

Recession July 1990-March 1991 8 months

Iraq invaded Kuwait on August 2, 1990

The Persian Gulf War, 1991 or Desert Storm Jan 1991

Hurricane Andrew 1992 very destructive United States hurricane

The Great USA Flood of 1993

Intervention in the Former Yugoslavia,

Dot Com Bubble, climaxed on March 10th, 2000 with the NASDAQ peaking at 5132.52

9/11 Attack, 2,974 people died

Recession March 2001-Nov. 2001 8 months, Airline Industry Collapsed

Enron bankruptcy in late 2001, employed 22,000

WorldCom, July 21, 2002, filed for Chapter 11

Iraq War, March 19, 2003 – 4,000 dead

Hurricane Katrina, late August 2005, 1,836 people lost their lives

Start of the Great Housing Recession or Sub-prime Recession 2006 or 07, 08? Date to be determined.

2008 Mar 20 03:03 PM

[dickjanine:]

I'm a "large investor" I like to make money. Is that "greedy"? I like to think I'm careful. Are you?

2008 Mar 20 03:11 PM

[Voice of Re...:]

Tie D should have stopped while he was ahead. He starting out saying "The FRB are idiots" No kidding. Uncle Ben and company are ALWAYS chasing the curve and accordingly behind it doing what they could have and should have done too little, too late.

Of course much of today's problems you can put squarely on the lap of my all time favorite FRB dummy, none other than goofy Greenspan, aka Mr. Mumbles who as yet can't utter a single sentence in public that makes any sense at all, yet you have presidents, Congress and of course the Bozos on Wall Street kissing the ground that silly old fart walks on. Go figure.

I'm a successful investor. Very. I've been doing it more years than Cramer (yes it is my full time "job" now and I listen to only ONE person for financial advise. MYSELF. Period. Others should try that. They would be a lot richer. Really.

So as long as I'm tooting my own horn, I'll share what I learned several decades ago thereby violating my own rule asking you to do what I have done. Investing, smartly boils down to being a GAME. The biggest game on the planet, anyone can play, few know the rules as simple as they are.

Rule #1 Markets go up on GREED. You can profit on that.

Rule #2 Markets go down on FEAR. You can profit on that too!

Rule #3 Don't fight the tape.

Rule #4 Have a plan and stick to it except when you need to break it which you will over and over. <wink> Read again till in sinks in.

Rule #5 Don't try to pick tops or bottoms, but DO pay attention.

Rule #6 If most people are buying you should probably be selling.

Rule #7 If most people are selling you should probably be buying.

Rule #8 There is no such thing as a "sure thing".

Rule #9 Yes, stocks can fall to zero value, thankfully not below.

Rule #10 Your best teacher is experience. Learn from your mistakes.

2008 Apr 01 11:46 PM

[dr55mac:]

We ought to creat a class of banks that are" too big to fail" and watch them much more closely like limiting their ability to leverage their accets more than 10 to 1. There are also big companies like GM and GE that need to be treated to constant daily checking by the government . Thgis would limit the total growth because some companies would like to have their credit sheets below the radar .

2008 Sep 17 03:51 PM

[jlpeterson:]

You might be interested in reading about the background of Bank of America and how it got too big to fail...My article on Associated Content spells it out.
www.associatedcontent....

Apr 03 12:10 AM