Nightmares realized as Bear goes belly up
Today was a day people involved in the markets will long remember.
Bear Stearns went belly up. The fifth largest broker on Wall Street. Its stock closed the day down 47%.
The immediate culprit seems to have been a sharp downturn yesterday in Alt-A mortgage bonds. (Alt-As include the non-documented type mortgages used by the self employed.) Bear is big in this market, and its collapse after a week of rumors about Bear’s condition led its lenders and clients to pull plugs Thursday.
The Fed jumped in before the opening bell Friday to take on Bear’s liabilities for 28 days, using JPMorgan Chase (JPM) as intermediary. During that time, everyone hopes, Bear will be bought at fire-sale prices by a major bank.
Recall that on Tuesday the Fed had pleasantly surprised people by announcing a new $200 billion credit program that brokers like Bear could use to unload wounded mortgage bonds in exchange for solid (knock on wood) Treasury bonds. But this new Fed window has not yet opened, so Bear was unable to find succor there today; hence the need to use JPM (which as a “bank” already has direct access to Fed credit) as an intermediary.
Looking back on the week it seems likely that Fed fears about Bear and likely others prompted the surprising offer to trade a ton of mortgage bonds for Treasuries. The Murdoch (formerly Dow Jones) Industrials had been up over 400 Tuesday on the news. Then gave the gains away across the next days, to finish about flat on the week.
Bear has been the posterchild of the credit crisis ever since it had two “hedge” funds (hardly hedged, it turned out) fail in July. The firm was the leader in mortgage bonds and has now fallen on that sword.
(In August and September, investor Joe Lewis made a big move to buy Bear stock, which had fallen from $160 to about $100. After today’s action, when Bear closed around $30, Mr Lewis had lost somewhere between $700 and $800 million on his investment.)
JPM and HSBC have been floated as the likely candidates to buy Bear — as soon as this coming Monday. But some say that the FDIC doesn’t have the powder to insure Bear, and thus that a bank cannot be a buyer, and that Bear’s portfolio of structured finance bonds is so complex that a quick kill seems unlikely.
Memories of 1987 were in the air today. The crash then — about 22% in a day, on a Tuesday — was preceded by a black Friday. Today (a Friday) the Murdochs fell, after wild swings back and forth, only 200 points. A mere 1.7%.
Next week the markets are only open four days. They will be hair raising.
The big question will be about “contagion,” as people like to put it. Will Bear’s fall lead to the dumping of a ton of wounded mortgage bonds and other assets on already frigid markets? Will the lack of confidence that killed Bear spread? Lehman Brothers — the second biggest mortgage bond player — seems the next to be tested, and was down about 15% today.
Monday will probably see Asia and Europe selling off in reaction to today’s USA action.
After the close on Monday, Bear Stearns will report on its last quarter (having moved the report up from Thursday in an effort to control damage).
Tuesday the Fed has its regularly scheduled Open Market Committee meeting, where it is expected to further cut the bank lending rates it controls, somewhere between 50 cents and a dollar — with everybody already saying it won’t do any good: the cuts so far have been killing the dollar but have done nothing to lower mortgage rates or make more money for home lending available.
Also on Tuesday, Goldman Sachs and Lehman Brothers report their quaarters, and Visa, the largest credit card system, has its much ballyhooed IPO. It will test the already poor markets — and if it fails to hold its opening bid will contribute to the doom and gloom.
Wednesday Morgan Stanley reports its quarter. Thus the week will see four of the top five brokers (all but Merrill Lynch) reporting, in the wake of Bear’s failure. The potential for panic (or its opposite) seems great.
Then, Thursday: triple witching expiration for futures and option contracts, usually a source of much “volatility”, as people like to say.
Then Black Friday. When Jesus died and the markets are blessedly at rest.
Fire on the mountain
Lightning in the air
There’s gold in them hills
And it’s waiting for me there
As the markets were melting this morning on the Bear news, Bush came out to give a speech on the economy, congratulated his people at Treasury in language reminiscent of his praise post Katrina of FEMA’s Brownie, and then spent most of his time stomping on various fix ideas floating about the Congress and selling a free trade treaty with Columbia, his new war buddy.
Last August it was clear how wide and deep this disaster could reach. No one in Washington — at the Fed, Treasury (ie White House) or Congress — acted, standing firm with bonehead Laissez Faire.
The toothpaste is now out of the tube. Bear Stearns fell not to insolvency but lack of confidence, and the latter cannot be controlled with the kind of logic that evaluates balance sheets.
One thing Washington can do Monday is directly support the wounded housing market, which remains the heart of the matter. The easiest way is to buy Fannie Mae and Freddie Mac mortgage bonds, which comprise something like half the mortgage bonds outstanding.
Now that the Fed has in essence bought Bear Stearns for a month, hoping for somebody else to do it permanently, the Laissez Faire ideological roadblock to buying Fannie and Freddie bonds would seem to have fallen into the same pit as Bear.
A better but, alas, bolder alternative would be to institute a fiat price control program that would allow an institution to carry wounded bonds on its books, where they could live out their lives in peace, probably producing more interest and returning more principal than the current (non existent) market value implies.
Or: A different and perhaps simpler means to same end: revise in part the accounting regulations passed in the 1993 that require institutions to mark these wounded instruments to (non existent) market.
If indeed the Bear contagion spreads, something very like the above may be the only solution; outstanding derivative bonds are numbered by the hundreds of trillions of dollars, and the Wall Street brokers — now vulnerable as never before — are the prime counterparties thereto. If creditors pull the plug on Lehman and/or others next week as they did this week on Bear … everybody, more or less, is insolvent.
