Bear Stearns Bailout The Worst Fed Mistake Ever? Really?

By now you know that a chap named Vincent Reinhart has dubbed the Fed's bailout of Bear Stearns as "the worst policy mistake in a generation."

I will leave trying to quantify the consequence to others, but it is worth understanding what this could mean if he is right. His use of the word "generation" applies a very long term connotation to when we might see the final shoe drop.

Much of the blame, rightly or wrongly, for today's problems is attributed to the Fed having kept rates too low for too long. Assuming that is true, it took three years for that to come home to roost.

We must assume that Reinhart thinks" the Bear Stearns bailout is worse than that - as I assume he knows what the word "generation means. If the scope and magnitude are as bad as he says, then we might be well into the next decade before this fully unwinds.

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In this context, many people fear a repeat of the 1970s and of course many have said this is the worst time since the Great Depression. Regardless of what you think of that, stock market-wise we have already looked like both the 1970s and the 1930s (different magnitude from the 1930s of course) which is a very long round trip to nowhere for the stock market.

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All three periods (1930s, 1970s and the naughties, heh heh) have plenty of differences too. In this current round trip to nowhere there have been plenty of places to make money. I suspect that if we have a 15 or 20 year, W-shaped round trip to nowhere there will be plenty of places to make money in the second half of the W.

Something I have mentioned before is that people in Japan also have financial goals that they are saving and investing for. Since 1989, a local investor in Japan has had no reasonable shot of reaching any far off financial goal in their stock market. This forced them to one way or another seek out closer to normal returns elsewhere.

I don't believe the US will be the quagmire that Japan has been, but if it takes another ten years for the market to get right then we all need to figure out what to do; we need to be resourceful enough to find normal returns elsewhere. Hopefully you have done some of this over the last few years.

In the post the other day about not caring about how much Greenspan is to blame, someone on Seeking Alpha heckled me with oh right, so the only thing that matters is the money in your portfolio. You are one good citizen.

Agreeing with the heckler, which is valid, seems to be more about solving the world's problems. My take portfolio-wise is more about each of us solving our own problems - or better yet, preventing our problems from happening. When my site started I was talking about seeing myself at 50% foreign in the coming years, which would be an effort to avoid a problem -- that being, below normal returns from the home market.

Regardless of whether the US market and economy are great or lousy over the next 20 years, we still need to save and plan.

Comments

[MuddlingInvestor]

I almost agree with your heckler. With a small correction:

Only thing that matters is MY portfolio.

As for being good citizen... World would be a much better place if everyone took proper care of her/his own matters.

[tuj]

The world would be a much better place if people stopped to think what effect their individual actions and exploitations actually had on the rest of the world. Not all of it, but a lot is a zero sum game.

[sivere]

The Fed, The worst decision Congress ever made?

TakeBackTheFed.com

[BalanceSheetChecker(BSC)]

The Fed will has explicitly signaled that rather than letting market forces determine the viability of a firm it will intervene to force a “stabilizing transaction”. In the case of Bear Stearns that transaction was at a price significantly below the book value and market price of the firm. The perverse result could, in fact, be massive destabilization as short sellers are emboldened by this very action.

The fact that Bear Stearns has never traded at-or-below JPMorgan’s offer price appears to signal the market's belief that Bear Stearns was/is actually worth more than the offer price (discounted for the likelihood that it will be taken over). Since “a government official advised Mr. Schwartz that a stabilizing transaction needed to be accomplished by the end of the weekend” it seems that the market was ultimately prevented from providing its own stabilization. Instead of supplying the short-term support that Bear Stearns apparently needed until the market was able to price its longer-term stability, the Fed-sponsored buyout gave a strong signal that short-selling the next target will be profitable. The Fed's actions set the precedent that it will not wait for, or encourage, the market to find a support level - it will withdraw lending in favor of a deal priced below any reasonable measure of value or support-level the market may be willing to provide if given adequate time. This will surely encourage future short selling.

In fact short selling financial institutions will be attractive even if the Fed doesn’t “stabilize” the next short target because neither will the market! The Fed has effectively removed any incentive for market participants to even try to provide support for the next target of a bear raid. If there turns out to be another run on a major financial institution the results will surely be much more damaging to the firm involved and to the Federal Reserves ability to promote confidence in the financial system. In that case calling the Fed's actions "the worst policy mistake in a generation" could turn out to be the understatement of a generation.