The Economist reports that the Federal Reserve is now doing something that it has done during the Great Depression and in the 1960s -- put its own capital at risk to keep the banking system from collapsing. The Bear Stearns Companies (NYSE: BSC) saw its stock lose 47% of its value today because no other banks will do business with it.
The Fed is creating the illusion that it is not bailing out Bear Stearns by using JPMorgan Chase & Company (NYSE: JPM) as the conduit through which its bailout will flow. JPMorgan will assume the Bear Stearns collateral and will forward the Fed's capital to Bear Stearns -- but this will only last for 28 days. Here's one way that the Fed is putting itself at risk -- if Bear Stearns' collateral declines in value, the Fed -- not JPMorgan -- will take the hit.
This move is not the first one that puts the Fed at risk. Earlier in the week, the Fed put $200 billion on the line and agreed to take Mortgage Backed Securities (MBSs) as collateral for those 28 day loans. Once again, the Fed is assuming the risk that the MBSs will retain sufficient value to protect the Fed's loan. But many questions remain:
- How much of a loss can the Fed afford to take?
- What does it say about the health of other Wall Street banks that JPMorgan was selected to act as a conduit for the Fed's bailout?
- What other banks are at risk of stirring a Bear Stearns-like panic?
- How will the fear spread among the highly leveraged hedge funds that hold MBSs as collateral?
- What is the limit of how much the Fed can bail out Wall Street before it just lets these banks implode?
- How much higher will inflation rise and the dollar fall as the Fed's futile efforts to bail out this crisis continue?
The Associated Press reports that the president made a speech -- observing that the economy is going through a 'tough time' noting "We believe in a strong dollar." With the dollar down 68% since he took office, it's not obvious that he means what he says. I am sure the policy makers in Washington will be working overtime to pull another rabbit out of their hat before the market opens again on Monday.
And I would like to believe that they'll come up with something that does not put the Fed at even more risk.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 1)
3-14-2008 @ 7:29PM
thebigkill said...
And the worst thing about Bear Stearns using the Fed of NY's capital? It forces the US taxpayer to be a shareholder in BSC on a day it declines 47% in market cap. And the Fed of NY can afford to lose as much capital as they can get away with until a public outrage ensues. Problem is workers are too busy just trying to make ends meet, and entrust public officials to do what's best for the country, not what's best to save private companies like Bear Stearns for the bad bets they made in leveraging themselves with CDO's.
Shouldn't we have a vote before we build a position in a company we see carries far more risk than reward? Maybe I should visit Chile for a couple of years. At least my money will appreciate there, and my taxes will go to public good instead of funding a company which free markets evidently this morning deemed unfit to function as an ongoing concern.
3-14-2008 @ 9:15PM
Faustling said...
What ever happened to the free market? Conservatives complain that burdensome government regulations are holding back economic growth . . . until the bubble bursts, and then they suddenly become advocates of Big Government intervention in the marketplace. This could all have been prevented with some timely policing of the mortgage market.