(some email q&a’s)

UPDATED as more questions come in!!

Why would shareholders approve this sale?

Answer, they may not. They may take their chances with getting more $ in bankruptcy.

Or a higher bid might surface.

The Fed has turned Bear Stearns into a ‘free call’ with their non recourse financing,

And the Fed has moved spreads of agency and AAA paper back towards ‘fair value’ with their openended funding lines. This removes ‘liquidity risk’ and allows the securities to return to being priced on ‘default risk.’

This has dramatically increased the business value of Bear Stearns.

The large shareholders can now say no to the sale, maybe add a bit of capital or take on a ‘business partner,’ and outbid JPM for the remaining shares (if needed).
Might even start a bidding war.

There could still be well over $60 per share of value for the winner.

And there’s a reasonable amount of time for them to put something together.

And maybe this was Bear’s plan all along.

They knew they needed Fed funding to maximize shareholder value, and the JPM involvement to stabilize their client base and buy the time to find a real bid.

(CNBC now showing a chart showing $7.7 billion in breakup value.)

---

Seth writes:

For 2 a share is Chase getting a boat load of non prime paper that over time is worth a lot more than 2?

From what I’m hearing it’s already worth maybe 75 or more.

And the Fed gave jpm a free call.

The $2 is the least that it’s worth, as the fed is providing non recourse funding for the assets at prices that support the $2 price.

And at the same time the Fed took action to restore pricing of agency and aaa assets to more accurately reflect their actual default risk, which is near 0.

---

This is different.In this case the moral hazard is in not funding the primary dealers.It’s too easy for the predators (other dealers, hedge funds, etc.) to first get short the stock and then start a run on any broker that has to have any non tsy inventory financed and drive them out of business.

By funding the primary dealers who are in good standing (they report their finances to the fed) and regulating capital requirements and haircuts predators are kept at bay and shareholders continue to assume the business risk of the primary dealers.

Steve writes:

And the Fed has said in times of crisis they will not punish the many for the few.

Moral hazard is not a fixed doctrine. It requires flexibility and in times of crisis they accept that their action (the Fed’s) will not address the doctrine. On balance it is a price (overlooking moral hazard) they must pay for the greater good.

They have done it in the past so doing it again reflects a degree of consistency not a change in policy.

---

Paul writes:

How do you respond to the moral hazard argument of the Fed bailing out Bear Stearns?

I’ll let the word ‘bailout’ go for now, and begin by saying the liability side of banking is not the place for market discipline, and it’s also probably not the place for market discipline for the Fed’s appointed (anointed?) ‘primary dealers.’

(I will also not here question the idea of having primary dealers in the first place, but don’t take that mean i approve of that setup, thanks!)

So given the Fed wants primary dealers, it then follows there are specific securities they go along with this assigned role.

Presumably those would include the likes of tsy secs, maybe agency paper, maybe AAA rated mtg backed securities, etc.

Presumably also are functions the Fed wants its primary dealers to perform, like being market makers, providing some notion of liquidity, etc. etc.

And, presumably, the Fed has some notion of public purpose behind this entire creation.

So, given all that, to support this ‘institution of public purpose,’ it behooves the Fed to ensure the primary dealers themselves have the available lines of credit to perform this vital public function (almost hurts to write that…).

The bank primary dealers do have ‘guaranteed liquidity’ and so are safely able to function as primary dealers, knowing they can always finance their inventory positions. This can be done via raising fed ensured bank deposits, and borrowing from the fed by using their inventory as collateral, etc.

The non banks were at a disadvantage to the banks in that they relied on the banks to fund their inventories.

Bear Stearns got shut down when the banks said ‘no’ for non credit related reasons. Bear had perfectly good collateral that they held as part of their primary dealer function (as defined by the govt regulations), and the banks said no, perhaps because they had their own internal issues.

The same would happen to the banks, and the entire economy, if the Fed simply said no to the banking system and one morning and didn’t open the payments system.

It’s just one of countless flaws in the institutional structure that doesn’t get noticed until it’s a problem, no matter how many times I’ve pointed it out to ‘authorities.’

So to your question, while I do see a lot of other moral hazard issues, I don’t see this as one of them.

The Fed simply told JPM to deal with Bear in the normal course of business and lend vs qualifying collateral as has always been the case, and as is the case when the Fed lends to JPM.

Let me know if I’m missing something, thanks!

(an email)

>
> On Fri, Mar 14, 2008 at 7:16 PM, someone wrote:
>
> Roubini sure did call it. I hope he is not on the money with
> his other calls.
>

Bear didn’t fold and didn’t have a problem due to a business failure. I’ll bet earnings (next week) are excellent, leverage is very low, and cash high.

liquidity is a strange animal. ge couldn’t fund itself one day a few years back on a stupid rumor.

i’d also guess bear doesn’t have a lot of, if any, miss marked securities, as that’s illegal reporting.

or securities where the cash flows are impaired. mainly because there aren’t many beyond the obvious equity type traunches of sub prime deals.

the securities pledged to the jpm/fed were all ‘qualifying’ secs and we’ll see Monday if funding those was sufficient to meet their cash flow needs.

that said, there will always be liquidity issues,

and people will get killed just as dead when someone yells fire in a movie theater were there isn’t a fire.

Bear Stearns could easily become part of a different name over the next few weeks.

The question for the Fed: Will further rate cuts help or hurt the credit crisis?

The Fed has been cutting to support the financial sector, and address risks (as they see them) of financial sector issues spilling over to the real sector.

How does the Fed see rate cuts helping the financial sector?

Lower payments for borrowers assist in servicing/refinancing outstanding debt and facilitate continued ‘borrowing to spend.’

However, in this cycle, it seems that rate cuts have been instrumental in the USD decline that correlates with rising gasoline/food/import prices.

‘Well anchored’ wages mean consumers are spending more on food/energy and have less for other goods and services.

And less for debt service, as evidenced by rising delinquencies and the (still mainly subprime, but starting to spread) deteriorating credit quality of consumer loan portfolios.

Yes, exports are increasing dramatically, supporting GDP, keeping the output gap reasonably low, but not increasing income for debt service where that is needed.

So the question for the Fed is, on balance, will further rate cuts help or hurt the credit crisis?

Will further cuts ‘ease financial conditions’ via interest rate channels?

Or will further cuts ‘tighten financial conditions’ via the current fx/inflation/debt service income channel?

And, even if those potential outcomes for the credit crisis are approximately equal, does the nod go to not cutting for reasons of residual inflation issues?

So far, not a single ‘real economy’ company has had problems beyond a slowdown in earnings and concern over future earnings. And slowdowns in sales have all been related to consumers being hurt by higher food and energy prices.

This implies the falling dollar/higher import prices is what has hurt the companies that have been subject to consumer weakness.

This implies Fed policy designed to protect the real economy from from potential spillover from the financial sector crisis has, as a side effect, done direct damage to the real economy.

And, of course, this is only relevant for the Fed if it comes up for discussion at the meeting on Tuesday.

Close friends tell me it probably won’t.

Consumer Price Index MoM (Feb)

Survey	0.3%
Actual	0.0%
Prior	0.4%
Revised	n/a

CPI Ex Food & Energy MoM (Feb)

Survey	0.2%
Actual	0.0%
Prior	0.3%
Revised	n/a

Consumer Price Index YoY (Feb)

Survey	4.3%
Actual	4.0%
Prior	4.3%
Revised	n/a

CPI Ex Food & Energy YoY (Feb)

Survey	2.4%
Actual	2.3%
Prior	2.5%
Revised	n/a

The calm during the storm.  March numbers are already being forecast at up 0.7% for headline CPI.

The individual components have been volatile.

Also, gasoline prices fell 2%.  Retail sales of gasoline was reported down 1% earlier this week.  Together this implies physical demand (gallons sold) went up.

---

U. of Michigan Confidence (Mar P)

Survey	69.5
Actual	70.5
Prior	70.8
Revised	n/a

Current conditions improved, expectations fell.

Inflation expectations one year forward rose from 3.6% to 4.5% which complicates the Fed’s decision on Tuesday.  The 5 year number fell from 3.0% to 2.9% which is somewhat of an offset.

Similar to the beginning of the end of the 1998 crisis when D bank bot Banker’s Trust when BT couldn’t fund itself, and then D bank funded Lehman and other dealers in a similar position to where Bear was yesterday.

Back then it happened after a three 25bp fed rate cuts. This time it happened after a total of 225 in cuts.

Today, JPMorgan Chase & Co. (NYSE: JPM) announced that, in conjunction with the Federal Reserve Bank of New York, it has agreed to provide secured funding to Bear Stearns, as necessary, for an initial period of up to 28 days. Through its Discount Window, the Fed will provide non-recourse, back-to-back financing to JPMorgan Chase. Accordingly, JPMorgan Chase does not believe this transaction exposes its shareholders to any material risk. JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company.

JPMorgan Chase and Federal Reserve Bank of New York To Provide Financing To Bear Stearns

Today, JPMorgan Chase & Co. (NYSE: JPM) announced that, in conjunction with the Federal Reserve Bank of New York, it has agreed to provide secured funding to Bear Stearns, as necessary, for an initial period of up to 28 days. Through its Discount Window, the Fed will provide non-recourse, back-to-back financing to JPMorgan Chase. Accordingly, JPMorgan Chase does not believe this transaction exposes its shareholders to any material risk. JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company.

If the euro hadn’t been as strong as it is, inflation would be that much higher over there.

Highlights:

European Inflation, Labor-Cost Growth Accelerate

European govt bonds lower after euro zone inflation hits new record

German Inflation Stays Above ECB Limit for 12th Month

Note the negative initial spin on inventories versus the falling stock sales ratio at the end.

Business inventories, sales up in January

by Lisa Lambert

WASHINGTON (Reuters) – U.S. business inventories rose by a larger-than-expected 0.8 percent in January, the biggest gain since 2006, while sales experienced their largest increase in nearly a year, a government report showed on Thursday.

Inventories exceeded Wall Street’s expectations of a 0.5 percent gain, and stood at a seasonally adjusted $1.46 trillion the Commerce Department said. The January gain was the biggest since June 2006, when inventories also rose 0.8 percent.

January business sales rose 1.5 percent to $1.16 trillion, the biggest gain since 1.6 percent in March 2007.

The stock-to-sales ratio, which measures how long it would take to empty inventories at the current pace, dropped to 1.25 months’ worth from 1.26 months’ in December. It matched the record low set in November.

The department also reported that retail inventories rose 0.4 percent in January, after remaining unchanged in December, to $507.73 billion. Sales that month increased 0.5 percent to $343.94 billion.

Import Price Index MoM (Feb)

Survey	0.8%
Actual	0.2%
Prior	1.7%
Revised	1.6%

Import Price Index YoY (Feb)

Survey	n/a
Actual	13.6%
Prior	13.7%
Revised	13.8%

Import Prices Ex Petroleum YoY

Survey	n/a
Actual	4.5%
Prior	3.6%
Revised	n/a

Exports MoM (Feb)

Survey	n/a
Actual	0.9%
Prior	1.2%
Revised	n/a

Exports YoY (Feb)

Survey	n/a
Actual	6.8%
Prior	6.7%
Revised	n/a

Inflation ripping via the ‘weak dollar’ channel.

Note: non-petroleum imports up 0.6%.

---

Advance Retail Sales (Feb)

Survey	0.2%
Actual	-0.6%
Prior	0.3%
Revised	0.4%

Retail Sales Less Autos (Feb)

Survey	0.2%
Actual	-0.2%
Prior	0.3%
Revised	0.5%

Retail sales soft, but not in collapse. That’s what an export economy looks like: domestic sales soft, while exports pick up the slack and support GDP, real terms of trade, and standards of living deteriorate.

---

Initial Jobless Claims (Mar 8)

Survey	357K
Actual	353K
Prior	351K
Revised	353K

Leveling off – nowhere near recession levels yet.

Would need to be 400K+.

---

Continuing Claims (Mar 1)

Survey	2835K
Actual	2835K
Prior	2831K
Revised	2828K

Moving a bit higher, but still far below recession levels.

---

Business Inventories (Jan)

Survey	0.5%
Actual	0.8%
Prior	0.6%
Revised	0.7%

Up some, but still much lower than prior to other recessions.

Retail sales weak today, but exports up over 16% earlier this week, and jobless claims now settling in around 350,000 – far from recession levels. That’s what export economies look like.

Meanwhile, non oil import prices up 0.6%, and export prices up 0.9%.

US GDP growth may be hovering around zero, but no collapse yet.

Meanwhile, Bush/Bernanke/Paulson engineered USD collapse/inflation/export boom is underway and accelerating.

It was like yelling fire in a crowded theater.

The world was happily accumulating over $700 billion per year in financial assets, and had a total of over $2 trillion, when our leadership yelled ‘fire’ and caused a reverse stampede.

Imports are real benefits and exports are real costs, and now we’re paying the price.

The MOF would have bought USD long ago if Paulson hadn’t gone around branding any CB a ‘currency manipulator’ and an international outlaw.

The USD is in freefall and is now the major source of inflation.

And maybe the Fed as seen the connection?

MOF Frets Over Yen, But No Hint Of Intervention

by Takeshi Takeuchi

(Dow Jones) Japanese currency authorities expressed alarm about the dollar’s fall close to the Y100-mark for the first time since 1995 but didn’t offer any clues about whether or when they might take any countermeasures.

Finance Minister Fukushiro Nukaga and his vice minister on currency affairs, Naoyuki Shinohara, separately voiced caution after the dollar fell to Y100.19 in the mid-day Tokyo session.

Nukaga said it is “a shared perception among the G7 (Group of Seven industrialized countries) that excessive exchange rate moves are undesirable,” while Shinohara also noted “excessive foreign exchange moves are undesirable.”

The two point men for Japan’s currency policy also said they will “continue closely watching foreign exchange markets,” a code phrase that shows their displeasure about current dollar/yen moves.

Neither of them, however, commented on whether they are considering taking countermeasures against the dollar’s rapid fall against the yen.

But Shinohara repeated the word “excessive” a few times in exchanges with reporters, suggesting the ministry’s level of caution has been at least raised in response to the imminent possibility of the dollar’s break below the Y100-mark.

In the past, finance ministry officials usually stepped up their currency rhetoric in stages before intervening. Their remarks on yen strength often changed from “rapid” to “a bit sharp” to “brutal,” while they also threatened “appropriate action” as an advance warning before intervening.

Countercyclical budget deficit growth could bring on a national credit crisis in the Eurozone that makes the current US situation look like child’s play.

This is their vulnerability that came with the Maastricht Treaty and has yet to be tested.

Italy Halves Growth Forecast, Sees Deficit Rising

by Flavia Krause-Jackson

(Bloomberg) The Italian government cut its 2008 economic growth forecast by more than half, as slumping confidence and rising prices threaten to brake expansion to the slowest among the 15 nations that share the euro.

The $2.2 trillion economy, Europe’s fourth-biggest, will grow 0.6 percent this year, the Rome-based Finance Ministry said today in a statement. That’s down from a forecast of 1.5 percent in December and would be the weakest rate of growth since 2005.

Italy may be the first and only country in the euro region to enter a recession this year and may have contracted in the fourth quarter, according to Morgan Stanley economist Vladimir Pillonca. Growth is slowing just as rising food and energy prices are fueling inflation and sapping consumer and business confidence.

“If you add to the mix an international situation that is now weaker than expected, this creates a real mess in a country where productivity was already declining,” said Luigi Speranza, an economist at NP Paribas SA in London.

Italy’s budget deficit will rise to 2.4 percent of gross domestic product, more than the 2.2 percent formerly predicted though still under the European Union ceiling of 3 percent. The shortfall narrowed last year to 1.9 percent of gross domestic product, the least since 2000, the Rome-based national statistics office said Feb. 29. That’s about half the 2006 deficit of 3.4 percent.

Note the fact that foreclosures went down a tad in February versus January is buried at the end of the article.

Number of US homes facing foreclosure jumps nearly 60 percent in February

by Alex Veiga

(AP) Nearly 60 percent more U.S. homes faced foreclosure in February than in the same month last year, with Nevada, California and Florida showing the highest foreclosure rates, a research firm said Wednesday.

AP

A total of 223,651 homes across the nation received at least one notice from lenders last month related to overdue payments, up 59.8 percent from 139,922 a year earlier, according to Irvine, Calif.-based RealtyTrac.

Nearly half of the homes on the most recent list had slipped into default for the first time.

Nevada had the nation’s highest foreclosure rate, with one in every 165 households receiving at least one foreclosure-related notice. It had 6,167 properties facing foreclosure, a 68 percent increase from a year earlier and up 1 percent from January, RealtyTrac said.

Most of the troubled properties were located in California, Florida, Texas, Michigan and Ohio — states where home prices have plunged as the housing boom went bust.

The overall U.S. foreclosure rate last month was one filing for every 557 homes.

February’s total represents a 4 percent dip from January, but the decline was just a seasonal blip, said Rick Sharga, RealtyTrac’s vice president of marketing.

“We seem to be settling in at a new plateau in terms of monthly activity, but it’s a much higher plateau than we were at a year ago,” he said.

>
>     On Wed, Mar 12, 2008 at 8:40 PM, Davidson, Paul wrote
>
>     Warren:
>
>     Don’t you think it was a strange open market operation –
>     where the Fed was moving Treasuries from their balance
>     sheets to private balance sheets (even temporarily) –
>     while accepting as collateral the highest grade mortgage
>     backed securities? Usually open market operations involve
>     Treasuries going one way and bank deposits (not
>     collateral) going the other way.
>
>

Hi Paul,

It was a ‘securities lending operation’ and was probably done that way to be in compliance with existing Fed regulations regarding interaction with the dealer community.

The Fed probably already had authority to lend securities to the primary dealers from their portfolio, and either get cash in return or other securities rated AAA or better (govt, agency, etc). So they offered to loan their tsy secs and accepted the dealer’s securities as collateral for the transaction.

Note that the dealers remain as beneficial owner of the securities pledged to the Fed in return for the tsy secs, and so the Fed is not assuming that risk. The dealers do get tsy secs which they can then in turn use as collateral for loans in the market place at much lower rates than loans vs the collateral they gave the Fed.

So the end result is the dealers get to borrow at the lower rates.

No ‘money’ is added to the system by the Fed. The Fed just sets rates as is always the case.

However, this is not to say they didn’t have other reasons for doing it this way. They continue to display a very limited knowledge of monetary operations and it’s not always clear why they do what they do.

Best to Louise!

Warren

MBAVPRCH Index

Survey	n/a
Actual	368.8
Prior	363.1
Revised	n/a

May be coming back after a winter weather lull.

---

MBAVREFI Index

Survey	n/a
Actual	2448.2
Prior	2569.0
Revised	n/a

Not all that much refinancing activity.

---

Bloomberg Global Confidence (Mar)

Survey	n/a
Actual	13.08
Prior	14.34
Revised	n/a

The whole world is watching CNBC.

The larger point is that ANY assets banks are allowed to hold already have to be on the regulators approved list, and banks in any case can fund all their (legal) assets with with govt insured deposits.

So why should another arm of government, the Fed, not always provide funding for the same govt approved assets that the govt already provides funding for? Why did it take them so long to come up with the TAF and now with the security lending facility?

And even now only with partial measures?

Clearly they are still in the dark on the workings of monetary ops and reserve accounting?

You may recall my proposal back in August (long before that, actually):

Drop the discount rate to the FF rate and open it up to any bank legal assets.

This should have always been the case.

The Fed’s ‘job’ is to administer interest rates, and that’s how you do it.

It’s about price, not quantity. Fed operations don’t materially change any of the monetary aggregates, as many who should have known all along have been ‘discovering.’

Yes, in good times the system did function reasonably well, but the risk was always there that in a crisis it would break down.

My other proposals remains equally valid:

Let government agencies fund via the Fed Financing Bank (at Treasury rates). They exist for public purpose, shareholders remain at risk for default losses, and lower interest rates would get passed through to the housing markets.

The Treasury should open it’s lending facility and lend Treasury securities in unlimited size to primary dealers.

Lastly, this is a good time to get the Treasury out of the capital markets and limit them to the issuance of 3 month bills. This would lower long-term rates, which is the investment part of the curve.

While problems in the US financial sector pose risks for the real economy, systemic risk to the payments system is not an issue. The US banking system has credible deposit insurance, so it is unlikely there would be any kind of run on the banks by depositors, and operationally the Fed can easily deal with it if it did happen.

In the UK, Northern Rock did have a run, but in the UK the BOE is there to provide funding as needed.

Not so in the eurozone where the ECB is prohibited from this type of action, and it’s up to the national governments to write the checks, and a major run on their banks has the potential to bring down the national governments.

European Banks May Write Down $81 Billion More, Merrill Says

by Poppy Trowbridge

(Bloomberg) Europe’s 11 largest banks may make additional writedowns of as much as $81 billion linked to U.S. subprime mortgages and have to cut dividends and raise money by issuing new equity, Merrill Lynch & Co. said.

“Banks are still playing catch-up on writedowns” following declines in the Markit ABX, CMBX and other indexes tied to subprime mortgages, Stuart Graham, a London-based analyst at Merrill, wrote in a note to clients today. “No bank has so far admitted to selling these assets off.”

In addition to writedowns from underperforming assets, lower profit means Europe’s banks will have to ease a cash shortage in the industry of as much as $104 billion, Graham wrote.

“We have assumed the European banks take significant further writedowns on” subprime mortgages, asset-backed securities, collateralized debt obligations and other derivatives, Graham said.

HSBC Holdings Plc, Europe’s biggest bank, HBOS Plc, Britain’s largest mortgage lender, Barclays Plc and Edinburgh-based Royal Bank of Scotland Group Plc are among banks that may make writedowns, Graham said. As many as eight banks may need to reduce their dividends by 20 percent and raise $84 billion in new equity.

The companies may also sell assets to raise money, he added.

–Editor: Ben Vickers, Adrian Cox

Trade Balance TABLE

Exports YoY

Trade Balance (Jan)

Survey	-$59.5B
Actual	-$58.2B
Prior	-$58.8B
Revised	-$57.9B

Exports up over 16.6% year over year (supports GDP) – looks like a banana republic!

Trade balance lower than expected with crude up to much. Should keep working it’s way lower all year as non residents work to reduce their rate of accumulation of USD financial assets.

---

IBD/TIPP Economic Optimism (Mar)

Survey	40.5
Actual	42.5
Prior	44.5
Revised	n/a

Down, but a little bit better than expected.

---

ABC Consumer Confidence (Mar 9)

Survey	n/a
Actual	-30
Prior	-34
Revised	n/a

Could that be a bounce back?  Haven’t seen one in so long can’t remember….

(A response to a comment about Fed policy changes)

On Tue, Mar 11, 2008 at 9:46 AM, Mike wrote:

the dollar may be the buy of a lifetime here….

Right, especially if the Fed cuts less than expected next week, or not at all.

Vicious reversal of commodities, USD, short term rates, but bad day or two for stocks.

This expanded lending facility may also function to increase the supply of short Treasuries for money funds and narrow the Treasury/LIBOR spread and shut up the rocket scientists who say low rates on short term Treasuries are the market screaming for rate cuts.

Highlights:

February Inflation Accelerates to 8.7%, Fastest Pace in 11 Years

Inflation continues to rip, and my guess is it remains underreported.

Fundamentally, this is not good for the value of the yuan, by definition, but timing is everything…

The Fed continues to show a deficiency in understanding monetary operations with the latest moves. While steps in the right direction, a better understanding of monetary operations would have meant funding ANY member bank asset at the FF rate and establishing an unlimited term lending facility for Treasury securities.

Meanwhile they seem to be trying to minimize further rate cuts and instead trying to target areas of illiquidity as per Friday and today’s announcements. They may have reached their inflation tolerance with crude at $109, the dollar continuously falling, and inflation expectations elevating.

Somewhat more troubling is the eurozone seemingly wanting dollar lines from the Fed. Not sure why, but borrowing external currency isn’t ordinarily a good sign.