Tuesday, March 25, 2008

Entitlement

by Tanta on 3/25/2008 08:42:00 AM

Yves at naked capitalism had a good post yesterday on the infamous Bear Stearns Ten Buck Rechuck, that I think needs repeating:

According to Sorkin, the $2 price for Bear was the Fed's and Treasury's idea; JP Morgan was prepared to pay more, but they nixed the idea, saying they did not like the "optics" of the deal. The implication is that the officials overstepped their bounds. That is a pretty outrageous spin when the government is putting up taxpayer money.

Had it been an option, the Fed should have nationalized Bear. It was going to declare bankruptcy Monday if there was no deal; its shareholders would have been wiped out. Why am I so confident of this view? If bondholders, as rumored, were buying shares to make sure the JPM deal went through (and thus would take losses on their stock purchases when the deal closed), that meant that they thought their bonds were worth well under 100 cents on the dollar in a bankruptcy. Shareholders are subordinate to bondholders, so equity owners would have gotten zilch.

I can think of a host of reasons, however, why the Fed did not go the nationalization route, the biggest being that it lacked clear authority (it couldn't declare Bear to be insolvent, as it could a member bank). And letting Bear fail (and having accounts frozen) was what the Fed was trying to avoid, so letting it fail and then seizing control (even assuming it could do that) was never an option. No doubt, the central bank also did not want to assume administrative control of an entity that it had never regulated (ie, its supervisors had never kicked its tires) that dealt actively in markets in which the Fed has little expertise. Even in an orderly liquidation scenario, that it a lot to take on.

Sorkin nevertheless argues that the Fed did Bear a dirty because:
.....the night that Bear signed the original bid, the Fed opened what’s known as the discount window to companies like Goldman Sachs and Lehman Brothers — oh, yes, and to Bear, too. Except that the Fed didn’t tell Bear that it planned to open the window when it was signing its deal with JPMorgan.
This verges on being revisionist history. First and most important, the discount window was opened to keep the panic about Bear from spreading to other firms, most notably Lehman. It almost certainly would not have happened then if Bear was not on the verge of imploding. Remember, a mere week and a day ago, there was pervasive fear that the wheels were about to come off the financial system, particularly if counterparties started getting leery of dealing with Lehman.

Moreover, usage of the new discount window the first week was light due to worries about stigma. If Bear had gone and used it aggressively, it may well have reinforced rather than allayed fears about the trading firm's health. If other firms continued to refuse to deal with Bear, its collapse was assured. There was a very real possibility that even if Bear had remained independent and used the window, its bankruptcy merely would have been delayed a day or two. And it would have been well nigh impossible to put together a three party takeover deal between the close of business in New York and market opening in Asia on a weekday.

But the most appalling aspect of Sorkin's account: he acts as if Bear had the right to be informed of the Fed's plans. Sorkin seems to have forgotten the golden rule: he who has the gold makes the rules. The Fed had every right to be calling the shots. They were taking the biggest risk in this transaction. The notion that a firm about to fail is entitled to be treated as a being on an equal footing with its rescuers is absurd. And the fact that Sorkin (and presumably others on Wall Street) sympathize with this view says the industry badly needs to be leashed and collared.
This, frankly, is the reason why I am so incredibly appalled by this:
Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities.

"I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview with the San Francisco Business Times. "Fixer-uppers don't bother us."

The San Francisco banker said any deal would have to meet the company's traditional acquisition targets and benefit the bank's acquired customers.
To even mention, in public, that one "wouldn't be averse to a Fed-assisted transaction" is to hint that the acquisition targets you are looking at are in as dire straits as Bear Stearns. What is Stumpf trying to do, start a run on an insured bank? Or, well, the other option is that Stumpf doesn't believe that Bear was such a mess--that, precisely, it is "on an equal footing with its rescuers."

Either way you slice it, the very fact that he could say such a thing in public tells you how far down the wrong road we've gone. I vote for the leash and collar, pronto.

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