This week we’re now getting a crash course in the greater monetary theory of the Fed in action: Too Big To Fail.
TBTF means that the big players in Wall Street are simply too big after a decade of mergers and buyouts to be allowed to fail, and this means if they get into any real financial trouble, they will be bailed out on the taxpayer dime.
The theory is that allowing a company that large to fail — a company allowed to be both a massive bank as well as a major investment house — would in fact cause lots more damage to the markets and the economy…not to mention the large Wall Street financials.
Today’s contestant is Bear Stearns.
Bear Stearns said its financial situation had “significantly deteriorated” during the past 24 hours and is receiving short-term financing from JP Morgan Chase to shore up confidence in its operations.
JPMorgan will provide a secured loan facility for an initial period of up to 28 days, allowing Bear Stearns to access liquidity as needed. The move is being made in conjunction with the Federal Reserve Bank of New York.
J.P. Morgan also said it’s working with Bear to secure permanent financing or “other alternatives” for the brokerage firm.
The Federal Reserve said it unanimously approved a new funding arrangement for Bear and said it would keep pumping liquidity into the U.S. financial system.
“Our liquidity position in the last 24 hours had significantly deteriorated,” Bear CEO Alan Schwartz said in a statement. “We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations.”
Schwartz added that “Bear Stearns has been the subject of a multitude of market rumors regarding our liquidity. We have tried to confront and dispel these rumors and parse fact from fiction.”
Bear Stearns stock has of course plummeted. It’s getting a handout from the Fed and JP Morgan, and billions more will be floated into the company to “increase liquidity.” As I’ve said before, when you hear the Fed say “increased liquidity” it’s really “bailout”.
Bear Stearns is not a small brokerage house. It’s one of the big Wall Street titans, and it’s on the ropes.
Bear Stearns Cos. plummeted a record 45 percent in New York trading after the New York Federal Reserve and JPMorgan Chase & Co. stepped in to rescue the fifth-largest U.S. securities firm with an emergency bailout.
After denying for three days that access to capital was at risk, Bear Stearns said today that its cash position had “significantly deteriorated.” The New York Fed agreed to provide financing through JPMorgan for up to 28 days, the bank said in a statement today.
Bear Stearns acted in response to “market rumors” of a liquidity crisis, Chief Executive Officer Alan Schwartz said in a separate statement. Schwartz said earlier this week that the company’s “liquidity cushion” was sufficient to weather the credit-market contraction. Traders have been reluctant to engage in long-term transactions with Bear Stearns as the counterparty, the Wall Street Journal reported yesterday.
This is the first major test of TBTF in action. If Bear Stearns goes under, confidence will be shaken. but what happens the next time a major Wall Street house runs into “liquidity issues”?
Why, the Fed will bail them out again. Money for nothing, checks for free.
The Fed said it’s “monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system.” The vote to approve the financing was unanimous, the Fed said.
The Fed’s already put half a trillion dollars into the financial sector for “liquidity restoration” purposes. It’s a bailout, plain and simple. Does anyone here think these companies are going to be in any position to pay the Fed back anytime soon, or ever?
Not me. The Fed doesn’t think so either.
The Federal Reserve is taking on the credit risk from collateral supplied by Bear Stearns Cos., which approached the central bank for emergency funds, Fed staff officials said.
The Fed lent the funds through JPMorgan Chase & Co. because it would be operationally simpler to accomplish than a direct loan to Bear Stearns, the staff said on condition of anonymity. The Fed said earlier today that its Board of Governors unanimously approved the arrangement with JPMorgan and Bear Stearns.
The Fed Board typically delegates discount-window lending authority to its regional reserve banks when it comes to loans to banks. The Fed invoked a little-used law that allows it to loan to corporations and private partnerships, which required a Board vote, according to the staffers.
The senior staffers declined to describe how large the loan to Bear Stearns is, and declined to say whether a private-sector bailout was attempted first before the Fed extended credit through JPMorgan.
Too big to fail. The Fed is taking on all the bad debt, all the bad mortgages, all the bad investments, and issuing cash for them in order to keep the system going. The problem is not liquidity, the problem is basic solvency. The symptom includes serious liquidity issues, but that’s not the actual problem. Everyone is acting like throwing money at the issue will fix the problem. It won’t.
I’ve explained a number of times why this is the case. We’ve just crossed another big fat line in the sand here with Bear Stearns, and the Fed’s response is what every Wall Street company will now expect to be bailed out every time, at every juncture, to the tune of billions if not trillions.
The problem is that the underlying issues that are causing these bailouts aren’t being addressed, because there’s nothing the Fed can do about them. They are treating the symptoms because there’s literally nothing else they can do. This problem is literally orders of magnitude more than the Fed can handle, and that’s the fact that the derivative market is swollen with hundreds of trillions of derivatives that are potentially bad. Will the Fed bail us out of that too?
Throwing money at the problem doesn’t work.
Billionaires Bill Gross and Wilbur Ross and the U.S. Securities and Exchange Commission failed to restore confidence in the $330 billion auction-rate bond market, as borrowing costs for states and municipalities rose.
Auctions for borrowers from San Francisco to Houston were unsuccessful even after Gross, who runs the world’s biggest bond fund, and Ross, who invests in distressed companies, said they were buying municipal debt to take advantage of rising yields. Thirty-year tax-exempt yields rose 6 basis points to 4.89 percent after falling 18 basis points last week from a three-year high of 5.01 percent, Municipal Market Advisors data show.
More than 67 percent of auctions failed this week, based on data compiled by Bloomberg. The market became unhinged last month, after dealers who supported the securities for more than two decades stopped bidding for bonds investors didn’t want. Auction rates jumped to 6.73 percent this month from an average 3.94 percent in the previous year, the Securities Industry and Financial Markets Association said.
“Nobody is giving me any inkling that it’s getting any better,” said Arnold Goldner, a 56-year-old owner of a jewelry repair business in Fort Lauderdale, Florida. Goldner said he hasn’t been able to sell $5 million in auction-rate preferred bonds sold by closed-end funds from Nuveen Investments Inc. and BlackRock Inc., which borrow in the market alongside cities, hospitals, colleges and student lenders.
The SEC said it may let borrowers bid on their own auction- rate securities to help end the freeze and avoid breaking laws against market manipulation.
Understand what we’re talking about here are multiple markets, each worth billions or trillions, that are coming apart and all at the same time. The only remaining question is “will this breakdown be bad enough to destroy the financial system in place?”
Every day, more and more evidence comes in that the answer is “yes”.
If you think it’s bad now, wait until next week, when the Fed cuts rates another 75 basis points (or possible more) with the US dollar already sliding into record low valuation territory. This next rate cut could very well trigger decoupling from the dollar in favor of the Euro, and if that happens, it’s all over.
We’re looking at the edge of the abyss here, and it’s close enough to be staring back at us.
Be prepared.
