BusinessWeek reports that the $29 billion "loan" that the Fed is making to finance JPMorgan Chase & Co. (NYSE: JPM)'s $1.2 billion acquisition of The Bear Stearns Companies (NYSE: BSC) is really an equity investment in $30 billion worth of mortgage-backed securities (MBSs).
If that investment goes sour, taxpayers will suffer. I think we deserve to know more of the details of those MBSs before the deal closes. For instance, what would a buyer be willing to pay for those MBSs in the open market? If the answer is 10 cents on the dollar, why should taxpayers be on the hook for the losses?
To do the deal, a Delaware-based limited liability company (LLC) will receive the $30 billion worth of Bear MBSs. The Fed will "lend" $29 billion to that company, which will pass all the money along to JPMorgan. JPMorgan will contribute a $1 billion loan to the LLC and BlackRock Financial Management will pay back the LLC's loans by gradually liquidating the assets. The Fed gets paid back fully before JPMorgan gets back anything on its loan. And if, after JPMorgan gets paid back, there's money left, the Fed gets it all.
But that last part is what makes the Fed's $29 billion an equity investment rather than a loan. If the $30 billion in Bear MBSs were treated as collateral, it would be a loan but since the Fed is a "residual claimant" -- e.g., it gets what's left after all the loans have been paid off -- Vincent R. Reinhart, a former director of the Fed's Division of Monetary Affairs that BusinessWeek interviewed, thinks the Fed's $29 billion is an equity investment.
Why does this matter? Because if things don't go so well and the $30 billion in MBSs are really worth, say, $5 billion, then taxpayers take a $25 billion hit. Not only that, but this move effectively marks a shift in U.S. policy from letting Sovereign Wealth Funds (SWF) in the Middle East recapitalize our banks to making U.S. taxpayers, via the Fed, the capital source of last resort.
Perhaps the SWFs have learned their lesson and there are no greater fools left. But before the deal goes down, we deserve to know a little bit more about Bear's MBSs -- and whether the Fed's balance sheet is sufficiently sound to handle this 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)
3-27-2008 @ 10:55AM
Dan Barnett said...
Mr. Cohan,
The problem remains that no one is really able to determint the value of the $30 Billion of The Bear-Stearns MBS.
As described here so brilliantly by Mr. Bissonnette & Mr. Liber, the issue is one of valuation of the underlying assets. Is Bear-Stearns bankrupt or merely ill-liquid? What about the "book value" when the stock was at $70? What are the assets really worth when there are no buyers?
& call me suspicious but if Bear-Stearns gets to supply the MBS that become the collateral of the loan/buyout, I'd guess that they would wind up being the most risky. If I were the Buyer, I'd start with A & work down the alphabet until I got to $30b worth. Better random than selected by the (maybe bankrupt) borrower.
3-27-2008 @ 1:02PM
Joseph Topolski said...
When Bear Sterns made millions in profits, the profits were private and spread amonst the partners/owners. Now there is a collapse by the same experts who shared in the profits privately. The answer is the losses are socailized and paid for by taxpayers funds. The government bails out the big guys but the samll guy who will lose his house due to forclosure gets $600.00. If this isn't an insult, I don't know what is. I bet the Bear Sterns execs still drive imported cars while the average guy has to walk or take public transportation.
3-27-2008 @ 2:16PM
Joe said...
Since when is it governments job to determine what companies go bankrupt and which do not? Our system works very well on it's own. It's when government gets involved that things get very shaky. If we were still on the gold standard there would be no reason for anyone to worry. There would be gold to back up the money. Now without the gold our dollar is losing all of it's value but I guess the fed thinks that is better than having the people who screwed up pay the piper.
3-27-2008 @ 2:19PM
donut999 said...
no question it is a bail out and an investment by
the fed, therefore the taxpayer. the story a
couple of months ago about the penn city that
invested $16 mil in siv's/cdo's with merrill. about
6 months later, they were worth about a dime on
the dollar. merrill made the city whole, but this
just can't go on forever.
2 worries. first that there maybe thousands of
institutions sitting on $300 mil to $1 bil in bad
paper. collectively, they will make the so called
big ones like bear, socgen, citi, etc look like a
drop in the bucket.
2nd and biggest, the fed has changed the rules
of capitalism. they are essentially doing the same
thing to bail out the big boys that all the greedy
mortgage brokers and others in the game did when
they loaned too much money to folks that could
not afford it with inadequate collateral.
the stool has been kicked out from under
capitalism and financial market fundamentals
in this country. the big boys profit, the taxpayer
gets hit in the head with the stool.
3-27-2008 @ 2:20PM
JHH said...
Whoever used to believe in 'the invisible hand in the marketplace' must now recognize the hand's visibility, and that the cuff at the wrist is closed by cufflinks owned by Bernanke. However, recognition is also due for the fact that there's a bag in the grip of the hand and who knows the worth of what's inside it. But the hand is attached to the body politic, that's us, and so it is we citizens who will be left holding the bag...
3-27-2008 @ 7:08PM
Tal said...
Why is it that guys like BS CEO can sell out stay rich and yes we the tax payer keep him in his extreme life style. They all make me ill. Poor management is rewarded and many employees loose their retirement. The BS CEO should fund a retirement fund for those poor people who have lost everything
3-27-2008 @ 7:22PM
prousa217 said...
hey guys: Learn this ...
technology increase productivity-true. One computer can increase productivity for one person. But, does 10 computers increase that one person's productivity? Absolutely NOT. Well, fed just put 10 computers out there!! Got it? Banks are hogging the fed's funds and kept it for themselves. So??????? Feds, what did you just do?? That wasn't productive , was it?
3-28-2008 @ 2:56PM
mrtcc said...
These are big and educated boys! Let them pay the price for being stupid and greedy! Screw bailing them or the damn banks out! Let them fail and everyone working there lose everything!!
4-11-2008 @ 12:20PM
Ryan Tew said...
ultimately this is entirely the fault of allowing big private banks to run the Federal Reserve. This has been coming since 1913 when the Fed was created essentially in secret and passed before congress during Christmas time when no one was around except those in the know.
Now we're reaping the benefits of a system that allows these monster banks to print money out of thin air and then pin the debt on the American Taxpayer by "lending" this money to the US Treasury.
If that isn't bad enough, the Fed is seeking the power to lend itself money when it wants and again gets to pin the debt/interest on the American Taxpayer.
two articles worth reading in relation to this one:
http://online.wsj.com/article/SB120768896446099091.html?mod=googlenews_wsj
http://www.safehaven.com/article-9920.htm