Is the SEC Really to Blame for Bear Stearns?

I'm not a big fan of Floyd Norris's column today, in which he essentially blames regulators in general, and the SEC in particular, for "letting leverage get so far out of hand" that Bear Stearns collapsed.

We all know that there's a big regulatory gap when it comes to investment banks - and that's a gap which Tim Geithner, Hank Paulson and others are trying to fill. So it's reasonable to complain that no federal regulator was really keeping a close eye on investment banks' balance sheets. But I think it's a bit much to jump from there to blaming the SEC for everything which happened.

Yes, the SEC, in the absence of any other regulator, was in charge of regulating Bear Stearns, just as it's in charge of regulating all other publicly-listed companies. And in fact the SEC did check up on Bear's capital adequacy on a daily basis. But it's not the SEC's job to set those requirements. Asking the SEC to do something which even the BIS finds all but impossible is, I think, unreasonable.

Yet that's exactly what Norris - and Chris Dodd, for that matter - is doing.

Is it reasonable to regulate the amount of leverage that investment banks are allowed to take on? Of course it is, especially if those banks get access to the Fed's discount window. But it has to be the Fed which is doing that kind of regulating, not the SEC. And in any case, it's hard to see what any regulator could have done to prevent the Bear Stearns collapse.

If counterparties like Goldman Sachs (GS) refuse to do business with another broker-dealer, that bank will go out of business sooner rather than later. No matter how much capital it has, and no matter how little leverage it has.

And while we're on the subject of Bear Stearns - again - I got a very good question in my inbox last night:

If JP Morgan (JPM) did cherry pick and dump the riskiest Bear assets on the Fed, then there's no mistaking the significance of the Fed $29 billion guarantee. If, as JPM claims, they didn't cherry pick, it seems that the relevance of the Fed guarantee might be very minor in relation to potential losses from the retained riskiest assets. Yet the deal couldn't be done without the guarantee. Am I missing something?

Any answers? I have to admit I was stumped. Thinking about it a bit more today, it does occur to me that with JPM paying only in the $1 billion range for all of BSC's equity, losing the risk associated with a $30 billion bond portfolio could make a significant difference to the purchase price, and possibly bring it up into positive territory. But I'm not even really convincing myself here, especially since JPM is now going to take the first $1 billion of any losses on that portfolio.'

One more thought: Aren't SEC filings fun? According to this one,

On March 24, 2008, JPMorgan Chase acquired 11,500,000 shares of Common Stock in the open market. The aggregate purchase price of $140,724,350 was paid out of working capital.

That works out at a price of $12.24 per share! Or, to put it another way, a 22.4% premium to JP Morgan's official bid price. The following day, Jimmy Cayne sold 5,658,591 shares at $10.84 apiece: his entire stake in the firm. One wonders why, if JP Morgan wanted to buy up shares in order to maximize the likelihood of the deal going through, they didn't do so when the stock was in the $4 to $5 range. One also wonders why Cayne didn't just sell his stake directly to JPM: Both of them would have been better off. Although that might not be legal, I don't know.

Comments

[VennData:]

The SEC should ask, is this bank "too integral to fail?" If the answer is yes. It should be broken up. That's the only way to allow the self-regulating mechanism to work, otherwise managers - and counter parties - can be assured they'll be bailed out. It's not so much the SEC but Bush's FTC that is to blame.

2008 Apr 05 09:43 AM

[Financial P...:]

Check your premises. You are assuming that the SEC is necessary to regulate leverage in the financial industry. However, it is the Federal Reserve System that forces the issue through the policy of fractional reserve banking and in turn influences other financial firms to follow suit regardless of whether they are in the banking business or not.

The SEC merely controls the flow of information, or is supposed to. The leverage is not bad, it is the idea that they can leverage as much as they want with no consequences. There is a Government body that stands ready to bail not only them out, but investors as well, be it the SIPC or FDIC.

2008 Apr 05 11:37 AM

[the final h...:]

i keep harping on "insider" information. the bid agreed on was $2.
JPM came up with $10. The final thus far is: 12.24.

who made all the damn money between the $2 and the $12.24?

2008 Apr 05 04:34 PM

[pansyed:]

It seems to me the final regulation should, in large part, sit with directors and senior management. Are they not the people who supposedly know what is going on? Don't they know what the risks are? In all the fuss the directors should be brought forward for their take on the mess. Should they not suffer further consequences?

Regulations are needed but it seems the directors and senior management made money for years and now get to walk away with a lesser amount of money than they could have with proper oversite but still very substantial sums of money. I agree with the previous comment about who made the money when the price was raised from $2.00 per share. Oh to be a fly on the wall.

2008 Apr 05 05:30 PM

[Balance She...:]

Cayne selling for $10.84, JPM buying for $12.24. Why? Optics. Any other way would "look bad". This way it "looks good". Cayne got the short end of the stick, that naughty ultra-high-earner, and look at, oh, how badly JPM wants BSC so it must be really good after all. That must mean there wasn't really anything wrong with financial markets in the first place, just a bit of panic, that's all! But that's all behind us now, isn't it. Just how the fed wanted it played! Perfect!

2008 Apr 06 01:07 AM