The Terrible Lessons of Bear Stearns
As Lehman Brothers (LEH) turns into a single digit financial midget on its way to zero, as Washington Mutual (WM) works its way towards a buck, as Wachovia (WB) drops more than 80% over a year, as Fannie Mae (FNM) and Freddie Mac (FRE) become divisions of the United States of America, and are now priced in pennies, as AIG continues to plummet -- we need to reflect upon the ongoing lessons learned from all these interventions by Treasury, Congress and the Federal Reserve.
The lesson from the Bear Stearns' bailout -- $29 Billion in Federal Reserve bad paper guarantees -- are quite stark:
• Go Big: Don't just risk your company, risk the entire world of Finance. Modest incompetence is insufficient -- if you merely destroy your own company, you won't get rescued. You have to threaten to bring down the entire global financial system. The fear and disruption caused by a Bear collapse is why it was saved. (AIG has the right idea on this)
• If you cant Go Big, Go First: Had Lehman collapsed before Bear, then the same fear and loathing of the impact to the system might have worked to their advantage. But having been through this once before, the sting is somewhat lessened -- especially for a smaller, lets interconnected firm like LEH (in the dot com days, we called this "First mover advantage!").
• Threaten your counter-parties: Bear Stearns had about 9 trillion in its derivatives book, of which 40% was held by JPMorgan (JPM). Some people have argued that the Bear bailout was actually a preventative rescue of JPMorgan. Its a good strategy if your goal is a bailout -- risk bringing down someone much bigger than yourself.
• Risk an important part of the economy: If your book of derivatives is limited to some obscure and irrelevant portion of the economy, you will not get saved. On the other hand, AIG's CDS might threaten much of the financial system. Mortgages are important, credit cards and auto loans are too -- but securitized widget inventory is not. To use a dirty word, Lehman's exposure is "contained," AIG's was not.
• Balance Sheets Matter: Focus on the media, complain about short sellers, obsess about PR. These are the hallmarks of a failing strategy -- and a grand waste of time. Why? Its call insolvency. ALL THAT MATTERS IS THE FIRMS' BALANCE SHEET. Lehman's liabilities exceed its assets, and they are now toast. Merrill Lynch got a lot of the junk off of its books, and got a takeover at 70% premium to its closing price. And Credit Suisse, who dumped much of its bad paper many quarters ago, is in a better tactical position than most of its peers.
• Unintended Consequences lurk everywhere: When the Fed opened up the liquidity spigots via its alphabet soup of lending facilities, the fear was of the inflationary impacts. But the bigger issue should have been Complacency. The Dick Fulds of the world said after Bear, these new facilities "put the liquidity issue to rest." Lehman got complacent once liquidity was no longer an issue -- perhaps they acted to slowly to resolve their insolvency issue in time.
Unfortunately, Moral Hazard has created terrible lessons in 2008 -- via Bear Stearns (BSC), Lehman (LEH), Fannie Mae (FNM) and Freddie Mac (FRE).
>
Previously:
Bloomberg Video: AIG Earnings
http://bigpicture.typepad.com/comments/2008/08/bloomberg-video.html
Monday, September 15, 2008 | 07:09 AM | Permalink
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» Greenspan: Tough Decisions Await In Lehman Case from Unpartisan.com Political News and Blog Aggregator
Former Federal Reserve Chairman Alan Greenspan says the government may face a difficult choice as it [Read More]
Tracked on Sep 15, 2008 7:19:25 AM
Comments
Amen. Greenspan's praise for deregulation and derivatives doesn't look so smart right now. And re-regulation of the financial markets will not help future earnings. What a mess!
Posted by: Katie | Sep 15, 2008 7:19:10 AM
But we must protect Goldman Sachs at all costs. See here - http://moneyistheway.blogspot.com/2008/09/we-must-protect-goldman-sachs.html
Posted by: Michael Fowke | Sep 15, 2008 7:28:18 AM
Sad, but true.
Are there any lessons for the financial media though? I mean, for months we've had to listen to these guys come on CNBC and basically unchallenged say everything is okay or at least, getting better.
As much as this is the result of a "credit crisis" it's also a result of a loss of confidence in our leadership, both financial and political. People are simply tired of being brazenly lied to.
You can't "shore up" the market with "confidence inspiring" moves when no one trusts you.
-DT
Posted by: Dinosaur Trader | Sep 15, 2008 7:28:36 AM
Barry says:
• Don't just risk your company, risk the entire financial world. If you merely destroy your own company, you won't get rescued. You have to threaten to bring down the entire global financial system.
Bank of America has bought several barges full of toxic waste over the last few months (years). It also controls something like 10% of all consumer deposit accounts. Is it now perhaps a systemic risk? Does anybody worry about this?
Posted by: Stuart | Sep 15, 2008 7:42:30 AM
Who bought Merrill Lynch's garbage though? Hopefully it was at a more realistic firesale price....
Posted by: JB | Sep 15, 2008 7:44:51 AM
So true! So any guesses on who is next? WaMu, AIG? Hey BofA could go easily go down too. Goldman, Morgan? The ponzi scheme is coming crashing down (well maybe not crashing yet)
Posted by: Viv | Sep 15, 2008 7:49:54 AM
The hedge funds have turned on their former masters.
Does anyone think this would have happened if LEH and BSC were still partnerships?
Posted by: Vermont Trader | Sep 15, 2008 8:04:53 AM
Martinis are going to be cheaper in Manhattan in 2009. Supply and demand.
Posted by: leftback | Sep 15, 2008 8:05:14 AM
Are there any lessons for the financial media though? I mean, for months we've had to listen to these guys come on CNBC and basically unchallenged say everything is okay or at least, getting better.
I hope it is clear by now that a great deal of post-mod finance capitalism depended far more on public psychology than private capital or enterprise. Another reason why we are where we are today is that the financial media, especially on the TV side, are (were?) nothing more than the propaganda wings of The Street.
Posted by: Will Divide | Sep 15, 2008 8:16:34 AM
Just a couple of points that I believe can ensure that this type of situation can never happen again:
1. Change the law so you can not walk away from personal debt and the debt follows you for the rest of your life. That should stop the "jingle mail" phenomenon. This actually the norm in most countries.
2. Change the law so shareholders are liable for any debt held by the company they own shares in. That should change the attitude of mindless, clueless private and public shareholders.
Anyway I believe the above is a lot cheaper then the mess created by Paulson & Bernanke.
Posted by: prismatic | Sep 15, 2008 8:18:27 AM
BR, I've got the feeling it's like WWI, we're all in the trench and the squad commander has blown the whistle to charge the enemy...
Posted by: Chief Tomahawk | Sep 15, 2008 8:18:50 AM
I'm taking WB in the death pool.
Posted by: E | Sep 15, 2008 8:31:13 AM
"I'm taking WB in the death pool."
Please don't, that's my bank. I'm way under $100k but I don't want to deal with it.
"Bank of America has bought several barges full of toxic waste over the last few months (years). It also controls something like 10% of all consumer deposit accounts. Is it now perhaps a systemic risk? Does anybody worry about this?"
I'm listening to Bloomberg radio while I work and the anchor just lambasted Bank of America's CEO for using buzzwords in his press conference to describe the Merrill Lynch buy. It seems BofA is being very smug about it.
'Synergy. What is synergy? What does that mean?'
Posted by: rj | Sep 15, 2008 8:36:50 AM
"Don't just risk your company, risk the entire financial world."
You'd think more companies would have learned this lesson especially after LTCM. That way you know you get rescued.
Posted by: Paul | Sep 15, 2008 8:40:09 AM
Where is Kudlow when you need him? I forgot he moved to Goldilocks land, right next to Never, Never land--lol
Posted by: gunthestops | Sep 15, 2008 8:42:44 AM
Credit Unions are looking pretty good right now.
Posted by: NSA | Sep 15, 2008 8:48:01 AM
Lewis better be God, Buffet and Christmas combined. When I think of impact of everthing that he controls, I shudder. A foreign entity can now make a run at them, when they get in trouble, and we suddenly become a subsidiary of Dubai, etc. Scary times for sure and I'm sure that we have not comprehended the impact by half yet.
What about the SIPC?
Posted by: larster | Sep 15, 2008 8:49:21 AM
Why does CNBC put all of the Bears on last night and then brings all the "Not on duly pesstimistic," types in the morning before the Open? They (CNBC) SHOULD BE HELD ACCOUNTABLE FOR THEIR SHCEDULING - think of all the investors that listen to there everyword (I know no one should listen but they do), and how it has supported a market equilibrium price that is totally abnormal. SHAME ON YOU CNBC!
Posted by: JustinTheSkeptic | Sep 15, 2008 8:56:31 AM
How much money would Helicopter Ben be willing to print to bail out BoA if it came to that?
Posted by: Mr. Peabody | Sep 15, 2008 8:57:14 AM
But there was still a huge bailout -- only indirect instead of direct. The Fed have said that the are now accepting a lot more types of paper to a lot higher limits than they were. This is code for "we are bailing out Lehman's creditors". Also the big surprise is Merrill Lynch. If anybody thinks that they lost their independence because they were happy to cash in, they are very wrong. The 70% premium? Well, the current stock price is not exactly the most awesome: http://finance.yahoo.com/q/bc?s=MER&t=my&l=off&z=l&q=l It was $17 against a 52w high of $78. The $17 price was last seen for Merill in 1996. BTW in the above graph there is is the usual extraordinary spike in 1995, when apparently fractional reserve requirements in effect vanished: http://www.signallake.com/innovation/FedReserve1995.pdf
Posted by: Blissex | Sep 15, 2008 8:59:54 AM
Ouch,
$irx is at 7.40
T-Bill Yields are now less than .75%
Based on that information and how Wall St. works
the Fed could/is about to cut rates 125 basis points.
Posted by: MarkTX | Sep 15, 2008 9:02:29 AM
How long before WaMu is bankrupt? Anybody has a feeling for critical dates for WaMU? Is it too big and complex to not be bailed out?
Posted by: WaMu | Sep 15, 2008 9:04:09 AM
I stopped watching ALL financial TV shows about 6 years ago - have been making much better investment decisions since. There is no information I need from TV financial journalism that I can't get from the internet or selected print media. Just get away from the emotion.
I will say that I learned one thing from Jim Cramer that I have found extremely useful - "Ringing the Register". Take profits on an investments when they have soared to unreasonable heights (also, in a short period of time). It may sound simple and obvious, but not that many actually do it. Cramer may deserve some ridicule in a couple of areas but this is one tactic that that has helped me tremendously and I give him full credit for it.
Posted by: Steve C | Sep 15, 2008 9:04:57 AM
Will,
Indeed.
-DT
Posted by: Dinosaur Trader | Sep 15, 2008 9:05:01 AM
MarkTX,
If what I am reading about the loss of confidence by the Chinese and others overseas is true, they are apparently going to get out of our markets and look for alternatives...if this happens, rates will go up. Just have to.
Bruce in Tennessee
Posted by: Bruce | Sep 15, 2008 9:09:02 AM
