Bear Stearns Bailout Implications

Everyone needs some time away, but those of us in the investment world never really get it.  Managing money carries with it the responsibility of monitoring information and staying in touch, no matter how talented the team on the front line.

We are talking with a lot of individual investors.  The doom and gloom is palpable.  It is no surprise that the viewpoints reflect the themes of the popular press and websites.  We plan to return to the broad themes, but let us take today's news as a case in point.

CPI Data

For a few minutes this morning the market celebrated the news that February CPI (seasonally adjusted) was unchanged.  The data critics were warming up.  How could gasoline prices be down?  (Answer:  Look at a chart.  This is February data, compared with January.  People are already thinking March).

There is a reason why those who are not economists and have never actually collected or analyzed data are so critical.  If no one believes the official data, they are free to propagate any argument based upon anecdotal evidence.  With the cost of living,  it is easy to point to items that have increased in price, ignoring any serious methodology or balance.

Bear Stearns

The story, as we now know it, seems to be that Bear suddenly and unexpectedly experienced a broad scale loss of accounts.  Since financial institutions do not and cannot keep enough cash around to meet all redemptions, this "run on the bank" carried a systemic risk.  Counter-parties of Bear might also fail.  Forced selling (yet another round) of illiquid assets would partly meet obligations, but might force another round of write-offs by other institutions.  In a couple of weeks, Bear would have been able to use the new Fed TLAF facility for this collateral, but could not do so yet.  Bear turned to its banker, J.P Morgan and described the situation.  JP Morgan could borrow from the Fed's discount window, but did not want to have the traditional "stigma" that comes with such actions.  The Fed agreed to backstop their action, leaving JP Morgan with no exposure.

What to Conclude

Explained in this way it seems like a success story.  Something that was completely unexpected created a major threat.  The parties involved acted swiftly and effectively.  While stock market traders aggressively sold financial issues, the major system threats were averted.

To realize this, ask what would have happened if Bear indicated insolvency with no support from the Fed.....

Some Comments from the Punditry

Bear lied. [How do we know this?  The "later" story was that rumors became a self-fulfilling prophecy.]

Bear caused the problem when the CEO went on CNBC to explain that "all was well."  Multiple pundits and traders today explained that this was alarming and caused the problem.  [A key feature of a successful CNBC interview is to show how smart you were about something that already happened.  Let's hear from those who caught this contemporaneously.]

The Fed has lost all credibility, according to a featured trader on CNBC.  This is because of  "what they said about interest rates."  [These trader comments are amazing.  The Fed acted much more rapidly than past Feds in similar historical situations.  They adjusted policy rapidly with new data.  We wonder if traders would prefer a situation where the Fed did not respond to data?]

Everyone in power is an idiot.  [Our view is that the Fed has been aggressive and creative.  Bernanke has acted more swiftly than past Fed chairs, and has also used creative means.  The TAF facility was disparaged by pundits at the launch, but was actually quite successful.]

We cannot trust anyone.  [This is the ultimate argument for pundits.  If the average investor cannot trust statements by the Fed, by any CEO, or by the government, then it is open season for those promulgating fear.  Fear sells.]

Conclusion

A top financial analyst came up to me today and stated that no one was bullish.  Everyone he talked to shared the view that all of the government officials were stupid, the data were manipulated, the recession would be severe, technical support had been violated, and the market might crash.  Everyone.

The dilemma.  So many are saying that the market has given a verdict.  If one thinks that the market is always right, in the short term, than there is no edge for the investor or the fund manager.

Comments

[RB]

And thus Jeremy Grantham's prediction of at least one major bank going belly-up comes true probably well ahead of schedule.

[Mike]

I think the only safe style of trading right now (aside from sitting in cash and doing nothing) is to VERY slowly scale in to weakness and wait for the inevitable ramps up (no stops, thus the VERY), still staying mostly in cash. Take profits relatively quickly.

[VennData]

The long run implications of BSC equity holders taking a massive haircut (or going to zero) is no increase in moral hazard. In fact, the animal spirits will be leashed rather tightly subsequent to the Fed's response, which, to me seems appropriate even if distasteful, expensive, and messy.

But it's certainly not bullish and it certainly shows the last few years have had much financial recklessness that will have to be washed out.

Northern Rock wasn't a bottom either, I agree that this has few positive short run implications.

[Ken]

What a great blog and some great advice to live by. I couldnt agree with the group more that consumer confidence is at an all time low.

Cheers

[joe]

The sentiment is very correctly covered. There seems to be a ~18 year cycle of consumer confidence and we're very close to the low again. Things compare to late 1990/early 1991.

[chartist]

great site, lot of inspiration for my work. thanks