JP Morgan Buys Bear Stearns
Expect a rough day on Wall Street. The talk today has to be on the financial markets. Last night the Federal Reserve arranged the sale of Bear Stearns to JP Morgan. JP is paying pennies on the dollar for a company that was supposedly “not in trouble.” At least that’s what Jim Cramer said.
The Federal Reserve had to take the extraordinary step of guaranteeing some of Bear’s securities:
To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns’s less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn’t describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.
Those securities are highly convoluted ones developed by financial engineers with PhDs in mathematics. Only those who dream about stochastic calculus and linear algebra would understand them. When they increase in value it’s a seller’s market. When things tank potential buyers start wondering what Bear was selling.
Mark this moment. I’m actually linking to a Paul Krugman column. He claims a federal bailout of the financial markets are soon on the way:
Last week, Robert Rubin, the former Treasury secretary, and John Lipsky, a top official at the International Monetary Fund, both suggested that public funds might be needed to rescue the U.S. financial system. Mr. Lipsky insisted that he wasn’t talking about a bailout. But he was.
It’s true that Henry Paulson, the current Treasury secretary, still says that any proposal to use taxpayers’ money to help resolve the crisis is a “non-starter.” But that’s about as credible as all of his previous pronouncements on the financial situation.
Megan McArdle, no sympathizer to government bailouts tries to reason with some of her libertarian brethren:
So JP Morgan has agreed to buy Bear Stearns at $2 a share. As others have already pointed out, this is, from the point of view of the shareholders, just barely better than bankruptcy. Talk of a bailout of the bank is silly–this wasn’t a bailout; it was an orderly winding-up of business.
This was always the most likely outcome–of the American bulge brackets, JP Morgan has the largest balance sheet and access to the Federal Reserve’s discount window. Now that it’s happened, we can breathe a sigh of relief that one gigantic disaster has been averted. Libertarians and liberals arguing against the Fed’s role in all this sound to me either ignorant or psychotic. The credit markets are already badly malfunctioning (yes, I was wrong). Bear Stearns is the counterparty to a huge number of transactions. Allowing it to fail would have been like throwing a hand grenade into a burning pool of gasoline; bankruptcy proceedings are time-consuming and uncertain. JP Morgan has the ability to assume their risks without any danger of going under themselves; that’s very good for the markets, and by extension, us.
We’re in the realm of second-best solutions.
Back to Krugman. He tries to claim Bear Stearns’ investors were somehow duped:
Bear was a major promoter of the most questionable subprime lenders. It lured customers into two of its own hedge funds that were among the first to go bust in the current crisis.
Hedge fund investors don’t get “lured.” Those funds have strong rules against promotion. Bear couldn’t advertise them like a company, say Fidelity, can market their mutual funds. Those looking for hedge funds have lots of money and presumably know more about investing than your average Joe. It’s odd a class warrior like Krugman is trying to turn very rich people who lost money as victims.
[picture via Dennis Gerbeckx]