Redstate

...but apparently there is contract language that commits Morgan to honor Bear's trading obligations even before final approval of the deal by Bear shareholders.

That would give people on the Bear side every incentive to drag this out in court.

It was a huge screwup, especially considering so many other deal terms were drafted very meticulously.

I welcome corrections on this.

foolish borrowers.

Also, it is not yet totally clear that Bear failed in the classic sense like, say, Enron.

From what I have read so far, it was like an overstocked, overextended supermarket with basically good inventory that succumbed to rumors that the food was poisoned.

I agree that you can not say that it was a bailout for BS equity holders.

But what about the debt investors- I assume BS had bank lines, bonds, and other debt. Are those investors taking any hit on the transaction? Maybe they should be, and therefore arguably its a bailout for them.

...as is standard in an acquisition.

The last time Bear published a balance sheet (late in 2007), they had about $270 billion or so in cash and $240 billion or so in long-term debt, if memory serves.

In the days immediately preceding March 13, the SEC reports that Bear's net liquidity was nearly $20 billion on almost every trading day. By the 14th, they were down to $2 billion.

but not necessarily standard in a purchase out of bankruptcy, which I believe is where BS was headed without the Fed backed JPM deal.

I took a look at the links Streetwise provided below. The problem with trying to assess whether debtholders were bailed out relative to what their outcome would have been in bankrutpcy is that as I understand BS problem, it was not due to a decline in their actual performance so much as a decline in their trading counterparties perception of their liquidity.

So its hard to say how the debt holders would have faired in a bankruptcy scenario- I have no idea if the market value of BS assets would cover the amount of BS debts, and if they needed to be converted to cash via forced liquidation, I bet they probably wouldn't.

So it still seems to me that the equity holders were not bailed out, the debt holders may have been bailed out (and I'm not sure that they should have been), and the trading counterparties almost certainly were bailed out with the outcome- but this was a necessary action to presever the overall financial markets.

An industrial company's debt generally finances hard assets which may have to be sold at fire sale prices. A company that leases much of its asset base (airlines or railroads) can reject unwanted leases in bankruptcy. Then the asset finance risk passes to the lessors and THEIR lenders.

A finance company has little in the way of hard assets. If Bear's problem was indeed short-term liquidity only, there may be nothing wrong with their asset portfolio. In an orderly market, those could be sold and the bondholders would recover most of their principal. But the Fed was concerned about a panic-stricken market.

Blackhedd is on the case! I suspect events will confirm his belief (as I interpret his writings) that the net cost to the taxpayer of the non-bailout will be quite minimal. We could even make a profit!

They did of course come right up to the edge of seeking bankruptcy protection.

The issue with a broker dealer isn't really whether they can pay off their debtholders. It's more whether they can both honor their trading obligations (counterparty risk), and continue to finance their asset portfolio on a nightly basis in the short-term money market.

When the liquidity rumors started, Bear's clients started pulling their accounts out, which turned rumor into reality. And then some major trading desks started hesitating to trade with Bear. That was the kiss of death, because Bear made most of its money by trading.

I was of the impression that the balance sheet was of limited help in figuring out what their actual asset/liability position was, given all the off balance sheet instruments involved.

So far as I can tell, the same is true for any investment bank in our brave new era.

n/t

http://finance.yahoo.com/q/cf?s=BSC&annual

http://finance.yahoo.com/q/bs?s=BSC&annual

I'm no expert in stock analysis, especially of broker/dealers, but some things do stick out:

-they borrowed $43 billion in the 3 yrs ending Nov 07
-they had a huge cash "inflow" labeled "change in liabilities for y/e 2007
-they had an even larger spike in outflow in their accounts receivable

It would be very interesting to know more about this!

...that a straight federal bailout of home mortgages is evil for a whole host of reasons.

In the first place, it's more of a bailout for mortgage lenders than for homeowners, because the lenders are the ones that have to write off hundreds of billions of dollars in foreclosed assets. A foreclosed homeowner takes a hit to his credit record, goes back to renting, and that's all.

Also the bailout gives free money to a lot of people who aren't in immediate danger of starvation, but are ready to take advantage of the taxpayers's generosity.

There's an assumption (voiced endlessly in news reports) that people who are now overextended on their mortgages were "preyed upon" by lenders and share no responsibility for their current distress.

A great many of these borrowers knew exactly what they were getting into.

Morally repugnant.

While I agree that folks should be forced to live with and learn from their bad decisions, it seems that there was in fact some duplicitous selling tactics involved getting people with no verifiable source of disposable income and little credit or savings into $500K McMansions. Since we are going to go down the bailout road in some fashion, as we tend to do cyclically with lenders, wouldn't it make more sense to "encourage" banks to adjust the principles based on more realistic calculations and fix interest rates rather than to allow mass foreclosures to have a further detrimental effect on the economy at large? I don't think this is completely fair, as those home sellers that made money off of this speculative housing market won't exactly have to give their profits back, but just as supporting this BS buyout serves the greater good at the expense of free market's apparent will, won't guiding mortgage assistance help the economy in the long run?

I'm going to step away from the moral hazard in individual cases because how are you ever going to get at the truth in every case, without millions of lawsuits?

In the larger sense, what happened was that we had a bubble in housing prices. At one level, this works just like a drop in the stock market. A lot of people were holding assets (residences) at particular valuations, and had borrowed money at those valuations. It takes two (a borrower and a lender) to agree to deal terms like that.

When the asset prices fell, everyone (the homeowners and the mortgageholders) was suddenly facing the disappearance of part of their wealth. It really is that simple.

You can slice and dice this any way you please, but would you be willing to give public money to stock-market investors to compensate them for their losses? I didn't think so.

If you lend money on an overvalued asset, you're not predatory. You're stupid. The lenders are professionals, and they need to get the slaughter they deserve. Washes the garbage out of the business.

It's impossible to say how many homeowners were predatory in taking advantage of the stupidity (and the scandalously lax underwriting standards) of lenders.

It's just one of those things. Everyone can spot a sympathetic homeowner who really does deserve to be made whole for mistakes she didn't know she was making. But how do you encode those standards into law?

I'm not entirely convinced that there are worthwhile macroeconomic reasons to swallow some of this moral hazard in return for a hope of a less painful recession. That's a big subject, and I could give you lot of arguments to the contrary. For one, the expectation of future moral hazard will need to be built into mortgage prices, making them more expensive than necessary.

Bingo! If someone else gets bailed out, the lender has to price acertain probability that I too am a deadbeat into any transaction I happen to conduct with that bank.

"I believe we must adjourn this meeting to some other place." - The last recorded words of Adam Smith.

As far as I know, no one talks about another possible victim of a mortgage bailout--the people looking to buy homes now. Imagine a family who thoughtfully considered all the financial implications of buying a home during the real estate boom and decided it was better for the time being to rent. Perhaps they were trying to save for a down payment (I know, old fashioned, but heck, this is a conservative website) or maybe they were completing their education. Anyway, the bursting of the real estate bubble would help these people find a reasonably priced home, rather than the stratospherically insane prices of a year ago.

There is nothing the gumment can do to halt the falling prices short of buying up homes at inflated prices and hanging on to them forever. Even that wouldn't have much impact because the supply is so great.

In Phoenix, at the height of the boom, there was about a two week supply of homes listed on MLS. Today there is a 16 month supply and the MLS is arguably artificially low because people have been cancelling listings like crazy and the vast majority of the REO is not on MLS. Our current MLS shows about 55,000 homes in Metro Phoenix (basically Maricopa County), and that's down from 69K in early February.

Home prices dropped over 20% year-over-year in Feb and we've still got probably another 20%+ to go.
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.

retirement condo in Mesa? Or does it have farther to drop?
What is the Sedona/Flagstaff market like?

Flagstaff happens to be the ONLY "non-declining" market in AZ.
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.

Chandler? Gilbert?
I don't think I could afford Scottsdale or Glendale, even in a cruddy market.

Nowhere in CA, FL, NV or CO either. The condo market is significantly worse than the single family home market in every major housing market.

Hang on another year or so and you might be able to afford all of Scottsdale.
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.

We have to sell that sfr in coastal WA yet. Can't do anything without that detail taken care of.
Been on the market 3 weeks, 5 lookers. Not panicing yet, but would like to get it sold here before the market gets flooded with all the summer transitions.

He moved from eastern LA county out to Bullhead City when I was in high school. Always talked about eventually moving to Sedona, tried to talk my parents into moving there, too. I think he stayed in Bullhead until he died (just a few years later) because my grandmother liked the 'scenery' next door in Laughlin too much.

HTML Help for Red Staters
"If we want to take this party back, and I think we can someday, let’s get to work." – Barry Goldwater

I'm an ant, not a grasshopper. I work, I save, I invest, and I am careful about the risks I take.

My homes are paid off. I have no debt. I have assets in stocks and bonds.

And, I am about to get royally scroooed by the massive inflation that will follow the fed's flooding the world with liquidity and the various bailouts of those who didn't save and didn't make careful decisions.

People aren't stupid. They watch and learn. If you want more risky and irresponsible behavior, reward it with a bailout.

The world's not going to meltdown if we let the housing markets find their own bottom.

Reward irresponsibility enough, and it becomes habitual.

"I believe we must adjourn this meeting to some other place." - The last recorded words of Adam Smith.

At least you own real estate so you'll benefit from the degree to which the bail out will inflate prices in the real estate market. Be glad you're not me: I fit your profile with the one difference being that I don't own any real estate. I'll get absolutely nothing out of any bailout. Except of course for the check.

-exits

No.

First of all, the major housing markets - FL, AZ, NV, CA for starters - are still overvalued by about 20% - 30% after falling 20%+ over the last 18 months. There is no action you can take, short of lenders writing down loans to current values that will effect that, and in the world of "really bad ideas" that would be number 1.

Second, we haven't seen the end of the default/foreclosure problems by a long shot. So far, everybody has just been focusing on subprimes and they are the tip of the iceberg. For example, Washington Mutual has an Alt-A pool of about $500MM of mortgages that have been rated AAA. Since October of last year the REO level on that particular pool has risen from 0% to 3.56%. The 60 day delinquent portion of the pool has risen from 11.5% to almost 23%. These are NOT subprime loans, they are typically loans to people will good to excellent credit and reduced income documentation (think self employed borrowers).

We will just start to see the meltdown in A paper this year and into next. The real implosion will come late this year and through 2010 when option arms start to adjust. Virtually every one of those borrowers will be significantly upside down on their property and their payments will go up by about $650 per $100,000 of principal. There are a high percentage of those loans in the markets that are already reeling - AZ, CA, FL and NV - and are typically on high priced homes and the borrowers have excellent credit and many are full doc loans.

The government simply needs to butt out. The mortgage markets have already taken draconian steps to tighten underwriting standards. FHA loans are moving quickly to be credit score driven (they have always been "common sense" driven) and subprime reduced documentation loans are long gone. High LTV loans are history.

Bottom line, some folks are going to get hurt and lose their homes. Others are going to take a big hit on their personal balance sheet. That's what happens when we treat our primary residence as an "asset" and not our "nest".
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.

I agree with most of what many of you have written. My concern is that thousands of homeless people, through no fault of responsible sellers and borrowers, will as a result of some of the dumber purchasers, and our tax dollars will go to help them anyway. I don't mind the government helping when you're a hardworking taxpayer that hits a rough patch (i.e. umemployment benefits) but the idea of helping those that willingly fooled themselves at the expense of the rest of us really turns my stomach. I guess I'm just saying if we have to do it, and it looks like we will in some fashion, we might as well try to get it right. We bought our home just as the bubble began to spring leaks, and we shaved 25% off the asking price (which was supposedly market value), so I agree, many homeowners can benefit from the current morass as well.

No one in the group of people holding mortgages who could be 'saved' by any sort of government bailout, would end up homeless were they to go through foreclosure. They would end up as renters which, frankly, is probably what a lot of them should have been all along.

-exits

The homeowners side of the equation is not what's hurting our economy right now. Yes, it's a ding in the overall growth, but not what's threatening a recession. It's the banks refusing to lend to each other that Blackhedd posted on earlier this week.

The "mass foreclosures" are supposed top peak at under 10% of all mortgages a year (last I checked, that was the prediction).
Back in the 70s, when foreclosures weren't on everyone's minds we were much closer to 20% of all mortgages a year, were we not? And we stayed there for a long time.

"Guns don't kill people...
"...But they sure help!"
-Paul Giamatti, Shoot 'Em Up

The next big disaster-in-waiting is the commodities market. I am curious how many people lost their shirt on gold, et al last week when the Hedge Funds started bailing. Plus I find the issues affecting commodities such as the barrel price of oil very subjective. - Terrorists blow up a pipeline in Iraq and the price goes up on what? Speculation it will hurt the global supply? Sorry that is a very speculative leap of faith which has a greater impact on daily life of everyone than some of this other nonsense.

"Nec Aspera Terrent"
bene ambula et redambula
Contributor to The Minority Report

Commercial real-estate.

One of the savviest men in the world, Sam Zell, essentially sold out all of his commercial real-estate holdings early last year, well before the excrement hit the fan in the residential markets.

As soon as I saw that, I knew there was trouble ahead. Zell knows hows to pick a top.

So what did he buy instead? The Chicago Tribune Company (which also includes the Chicago Cubs baseball team, and the Los Angeles Times). Go figure.

Commodities seem to be tracking the dollar up and down, and have been very strong the last day or so. The inflation picture is very, very convoluted. I should try writing a post about it.

Oh, and hurricanes generally. Bad, Bush! Bad bad bad!

NEVER, ever, stand between a "gentleman" and his money.
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CongressCritter™: Never have so few felt like they were owed so much by so many for so little.

True, but does a bank really want the Fed as an enemy??

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And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

be reporting capital losses, assuming the GAAP rule of "lower of cost or market" applies to them, which I believe it does.

Then if the fed were to raise short rates, where they have more control, the carrying cost would go up when the first batch of loans expires and has to be renewed at higher rates.

This doesn't prevent them from arbitrage, but might make them think twice. I hope!

Sure, if long rates rose, the firms would lose some money on mark-to-market accounting, but the net result at liquidation would be a profit as long as the long rate remained above the discount rate.

Good point about the impact when the Fed raises the short rates, but even for 28 days, or however long the loans are from the discount window, the banks could still make a substantial profit. And if banks started undertaking this transaction, the increased demand for treasuries would depress rates, not increase them. Plus, the liquidity in the market for treasuries would allow the banks to dump their treasuries should short rates rise above long-term treasuries.

I just wonder if Bernanke called Blankfein, Fuld, Mack, etc. and threaten to shut the window should they use the discount window for arbitrage purposes.

***********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

he has a phone :>)

he has a phone :>)

without borrowing at all, as long as their credit holds up.

But now we're getting into Master-of-the-Universe territory, which is alien to me.

Hmm..yeah that's all alien to me as well. I think there's a RS member called bondtradergirl that probably knows more about this. Hopefully she'll pitch in her two cents if she sees this.

********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

I was intrigued enough to send her an email but she snubbed me.

Yeah, that's right.

That's too bad. She said in another thread a month or two ago that she builds trading platforms. I never bothered emailing her to find out more, though.

**********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

The discount rate is essentially a "penalty" rate, a little too high to make this trade work. (I didn't run the numbers, just thumbnailed it on the back of an envelope.)

Remember, you need to find something to do with the money after you've traded long-dated Treasuries for it. If you lend it in the repo market, the trade doesn't pay out. If you take risk with it, you might get skinned.

Something like this happens in the overnight repo market, when people do "specials" (which are repos that specify a particular security as the collateral), but they're usually done at a rate below the general collateral rate.

The thing you'd really worry about in this arb, though, is market risk. Interest rates farther out on the yield curve are too low to pay you back for the risk.

At least that's what my envelope says. Your mileage may vary.

Re borrowing at the discount window generally: there is a stigma attached to it, at least among commercial banks. It's well understood that it's a last resort.

And the discount-window lending facility for broker-dealers is supposed to expire in six months anyway.

The discount rate is 2.5%, if my memory serves me correctly, and 10-year Treasuries are at 3.5%. If banks could create a hedge against the interest rate risk at a cost of less than that one percent rate differential, I would think it would be an arb opportunity. I know next to nothing about these types of hedges, and so I don't know if it is possible to create a successful hedge in this manner at a reasonable price.

Stigma: true, but if word leaked that one of the banks profited wildly from the discount window, I'd expect to see that stigma quickly evaporate.

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And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

...$10 million worth of the 10-year note. The Fed needs to be compensated for the market risk, and they'll take a haircut. That alone might be enough to take out the arb.

But you're thinking, which is good! Something tells me by the later in the year, you'll know more about this stuff than I do.

Ohhh yeah. Good point.

Thanks! Haha, I doubt that, though I will know quite a bit more than I do now.

********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

...shop it around.

Basically, there's no arb. For one thing, the Fed marks your collateral to market so you face the risk that the 10-year note will fluctuate in price. (And look at the chart: since January, it's moved between 3.3% and 3.9%, that's a huge risk.)

For another thing, this kind of trade is generally done as a repo. The Fed gets the income from the original collateral you put up. So in addition to the (high) discount rate, you're also paying the forgone interest from your collat, and you're still paying repo-rate interest to whoever you borrowed from to get the collat in the first place.

And finally, the Fed knows all these tricks. We like to think that the government is full of incompetent morons, but the Fed, the Treasury, and the SEC are very hard to mess with. And you really don't want to mess with them in the first place.

Ok, that pretty much nails it. Thanks for looking into it.

On a different note, WSJ just reported that Jimmy Cayne unloaded $61.3mil (5.66 million shares) of stock...which tells me the $10/share deal is pretty much guaranteed.

***********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

That would be just about his entire stake. Was worth nearly a billion dollars a year ago. Tsk, tsk, tsk.

There are plenty of people on the Street that are quietly happy to see Jimmy get the shaft.

Wonder who handled the block trade? Wouldn't it be funny if it was Goldman?

Admittedly, I do feel a little bad for the guy. It must be rough on *anybody* to lose that kind of money in about 2 weeks. Though he pretty much deserves it after the way he responded to the credit crisis: "Another round of golf, fellas?"

I was wondering the same. I hope its JPMorgan -- they would probably ask for his other arm and leg for executing the transaction.

**********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

...although there was a volume spike just before the close and another one three days ago.

Either someone did a really good job of shredding the block (which is why I thought of Goldman), or Cayne executed an off-market transaction.

But why bother, unless he thinks there's a chance that the deal will go off below $10?

I'll try to find out in the morning.

Just read on MarketWatch that the trade was executed on Tuesday.

**********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_

yeah, the poor bastard ONLY has $61MM now. What a tragic story.