Bankers step in, bail out Bear Stearns
Famed institution hit by run on liquidity
BARRIE MCKENNA
March 15, 2008
WASHINGTON -- U.S. banking authorities have tapped a Depression-era financial tool to save Bear Stearns & Co., Wall Street's storied fifth-largest investment bank, from succumbing to a wave of contagion sweeping through the lending industry.
The loan to the 85-year-old Bear Stearns, which survived the Great Depression and a world war, marks the first time the U.S. Federal Reserve Board has stepped in to bail out an investment bank.
After repeatedly and vehemently denying rumours of liquidity woes, Bear Stearns said it sought help from the Fed late Thursday after what analysts described as a classic run on the bank. The Fed is providing the infusion through JPMorgan Chase, Bear Stearns's main banker.
And so it goes with the U.S. credit crunch, which erupted last summer in the esoteric market for high-risk home mortgages.
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Officials keep insisting the problem is manageable and contained, only then to see it infect another corner of the banking industry - in the United States, Canada and around the world.
A majority of economists now believe the powerful U.S. economy has probably slipped into a recession, as a growing number of consumers and businesses run into credit trouble.
Bear Stearns, which has been stung by a series of bad bets on subprime mortgages and leveraged hedge funds, suddenly experienced "pretty broad cash outflows" on Thursday, chief executive officer Alan Schwartz conceded to investors and reporters in a hastily arranged conference call.
"Frankly, this is a bridge to a more permanent solution," he said.
Investors weren't impressed. Bear Stearns shares tumbled nearly 47 per cent to $30 (U.S.) yesterday - the largest one-day fall in its history. Standard & Poor's and other credit rating agencies scrambled to downgrade the company's debt, a move that exacerbated its financial stress.
News of the historic bailout triggered a broad sell-off on North American stock markets. The Dow Jones Industrial Average fell more than 194 points to 1,1951.09, or 1.6 per cent, a decline mirrored by markets elsewhere.
On Wall Street and elsewhere, skittish investors are continuing to flee to the safety of gold and oil futures, and away from the U.S. dollar amid widespread concern that the United States has slipped into recession.
Mr. Schwartz insisted the emergency 28-day loan would allow Bear Stearns to quickly resume normal operations. But the company is reportedly being shopped around already by financial adviser Lazard Ltd. to potential buyers, including JPMorgan and others. Other reports suggested the company could be wound down, with its best parts sold to others.
Among its mounting problems, Bear Stearns was a major creditor to the $21-billion (U.S.) Carlyle Capital hedge fund, which collapsed earlier this week after creditors lost confidence in its ability to pay its debts.
Experts worry that Bear Stearns might be just the tip of the iceberg, and that other financial institutions might be on the verge of collapse.
"The greatest credit bubble of all times has burst," said economist Ed Yardeni of New York-based Yardeni Research Inc. "The consequences are getting exacerbated by the greatest margin call in the credit markets of all times. The Fed and other government agencies really don't have much choice but to provide the greatest bailout of all times."
Rumours were swirling yesterday that Lehman Bros. might be the next U.S. investment bank to face liquidity problems.
The Bear Stearns bailout has sent "reverberations throughout all markets worldwide," said Sherry Cooper, chief economist at BMO Financial Group in Toronto.
"Not only because this is another 'too-big-to-fail' scenario, but also because it has strong implications for a domino effect in the already weakened financial services industry and beyond," Ms. Cooper wrote in a research note.
"... Other firms will likely continue to suffer the results of the credit crunch and loss of investor confidence."
The crisis at Bear Stearns comes just days before the Fed's next scheduled rate-setting meeting Tuesday in Washington. Economists had expected another half-a-percentage-point rate cut. Many now predict the Fed will have to lower its benchmark rate as much as three-quarters of a percentage-point to deal with the worsening housing slump, a possible recession and now a more extensive freeze-up of credit markets.
"Events are extremely fluid," agreed John Silvia, chief economist at Wachovia Securities. "If Bear Stearns or another major financial institution fails, a major financial panic would ensue."
The Fed would have to lend even more money to troubled financial institutions, but it would also have to "cushion the blow to the real economy," Mr. Silvia said.
Fed chairman Ben Bernanke hinted at the extreme pressure he is under as he prepared to deliver a speech on the housing market in Washington yesterday. "I've had a busy morning," he told his audience.
In a brief statement acknowledging the Bear Stearns loan, the Fed said it is "monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system."
The Fed is now throwing all of its resources at the credit problem, but, so far, with limited success. Among the Fed's main challenges: Mortgage rates are continuing to climb, even as the central banking system tries to force them down because lenders are loath to lend to anyone. And tighter credit will lead to more foreclosures, still lower house prices and a squeeze on consumers.
The Fed has already cut its key interest five times, to 3 per cent from 5¼ per cent since last August. It has also announced a series of measures to inject liquidity in problem-plagued corners of the lending industry.
The Fed, for example, this week set up a special $200-billion, 28-day lending arrangement, under a provision created in the 1930s to counteract runs on banks. Bear Stearns is its first beneficiary. The plan was announced as part of a joint effort by central banks in Canada, Europe and elsewhere to boost liquidity in the banking sector.
Under the Bear Stearns deal, the Federal Reserve Bank of New York agreed to provide an unspecified amount of secured funds to JPMorgan Chase, which in turn would make loans to Bear Stearns. JPMorgan Chase said it is "working closely with Bear Stearns on securing permanent financing or other alternatives for the company."
The bailout didn't sit well with many analysts, who complained that it creates a moral hazard to a company that took undue risks in the mortgage market.
"Instead of letting Bears Stearns get crushed, and then see the assets and talent pool get scooped up by someone else, we keep a wounded Bear on life support hanging around," remarked Barry Ritholtz, director of equity research at Fusion IQ.
"My preference is creative destruction."
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