'Fedization': Bear's Rescue Presents a Major Moral Hazard

by: The Prudent Investor posted on: March 24, 2008 | about stocks: BSC / IAI / IYF / JPM / XLF    

Ladies and gentleman, please welcome a new economic term. As the privately owned New York Federal Reserve starts out on a banking shopping spree, the new twist in the latest systemic crisis of the financial sector shall be called 'Fedization' in contrast to the old-fashioned nationalization that stood at the end of past banking crises.

The Federal Reserve has now entered the casino in a sacrilegious way, by taking (in)direct stakes. Forget level playing fields, some investment banks will be more equal than others, withstanding all contrasting official statements to come.

What's next on the shopping list? General Motors (GM), Starbucks (SBUX) coffee served by the Fed or more funny paper for a share in Fannie Mae (FNM) and Freddie Mac (FRE)?

On Monday the NY Fed announced that it would form a limited liability corporation that will provide another $29 billion in financing for JP Morgan's (JPM) purchase of Bear Stearns (BSC). This LLC will receive $30 billion in assets from JPM as collateral for its loan, financed at the discount rate of 2.5%.

The statement says:

At the closing of the merger, the Federal Reserve Bank of New York ("New York Fed") will provide term financing to facilitate JPMorgan Chase & Co.'s acquisition of The Bear Stearns Companies Inc. This action is being taken by the Federal Reserve, with the support of the Treasury Department, to bolster market liquidity and promote orderly market functioning.

The New York Fed will take, through a limited liability company formed for this purpose, control of a portfolio of assets valued at $30 billion as of March 14, 2008. The assets will be pledged as security for $29 billion in term financing from the New York Fed at its primary credit rate.

JPMorgan Chase will bear the first $1 billion of any losses associated with the portfolio and any realized gains will accrue to the New York Fed. BlackRock Financial Management, Inc. will manage the portfolio under guidelines established by the New York Fed designed to minimize disruption to financial markets and maximize recovery value.

This stinks as does the rest of this multi-billion deal where I am still looking for the actual cash involved. So far I can only see several layers of debt. Why is this portfolio valued at prices of April 14? What happened to realtime data? How much is this portfolio worth today?

According to the WSJ, taking it from the NY Times, JPM will now exchange 0.21753 shares for every Bear share, effectively quintupling the original offer of 0.05473 shares. No cash here.

The offer was also sweetened with an issue of 95 million new Bear shares JPM will buy until April 8, giving it a 39.5% stake in outstanding shares. No mentioning of cash here either.

The WSJ has the full text of the "merger" agreement here. According to it JPM will enact an exception of the NYSE's Shareholder Approval Policy which provides an exception in cases where the delay involved in securing shareholder approval for the issuance would seriously jeopardize the financial viability of the listed company.

While this may be good news to Bear debt holders, this action by the NY Fed raises the question of whether Fedization will be a new precursor in the century-old banking cycle that provides dividends for shareholders in good times and a nationalization of losses at the end of every monetary expansion process.

The Fed as a step-in continues to keep the mountains of pretensions markets are helped with since August 2007. Pretensions such as: The Fed pretends the collateral has a value and markets pretend the freshly digitized billions of credit are money.

I also fail to understand what it means that the Fed will absorb the first billion of losses on the collateralized portfolio. Is this an effort to build trust that the Fed actually sees value in this portfolio?

Anyhow, I am confident that the new twist in cleaning up the mess will not have been seen for the last time now that the NY Fed has opened the floodgates, with the official encouragement of the US Treasury Dept. There are many more investment banks under the waterline that cannot be nationalized as the state certainly has no function in taking part in what is effectively institutionalized gambling.

But the question of moral hazard has probably never been of higher importance than nowadays as Nanny Benny works overtime to help bankers stay in their mansions.

Fedization is here to stay - and will probably grow much larger before the year is out.

This article has 9 comments! Add yours below...
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This article has 9 comments:

  •  
    CarlosSlim
    Mar 24 05:32 PM
    My Website
    The Fed absorbing losses on the collateralized portfolio means...

    TAXPAYERS will have to pay for the cleanup of the fraud, waste and abuse that comes from lack of "regulation" of financial industry practices.

    Just like Taxpayers have paid around $125 billion to bail out Savings and Loans from 1986 to 1996.

    Socialism for the Rich, Law of the Jungle for the Poor...that's the Republican way!
  •  
    Jonathan
    Liss, SA
    Editor
    Mar 24 05:38 PM
    Why blame only the Repubs? Clinton was in office during the second half of the time frame you mention above. This issue is one that unfortunately crosses the aisle in my opinion - both the Repubs and the Dems are to blame!
  •  
    Nate C
    Mar 24 05:53 PM
    The Feddoes not give a damn about "moral hazards." The Fed is owned and operated for the benefit of the banks. The Fed is just doing their job--bailing out their owners who are got into trouble with MBS. The Fed is an illegal institution that can do anything it wants with almost no oversight by Congress. Most of the simpletons in Congress do not even know what a MBS is. They only know the buzz words like "liquidity" and "bring stability."

    The Federal Reserve needs to be closed. They recklessly debase our currency and reduce our purchasing power by lowering interest rates to rescue the wall street banks. And guess who gets to pay for all of this: the US taxpayer as usual.
  •  
    Wez
    Mar 24 06:38 PM
    This new deal does stink to high hell.
  •  
    deefree
    Mar 24 06:50 PM
    My Website
    giving investment bankers access to the Fed window is like giving a crackhead access to a cocaine mine.
  •  
    User 167540
    Mar 24 07:07 PM
    "On Monday the NY Fed announced that it would form a limited liability corporation that will provide "ANOTHER" $29 billion in financing for JP Morgan's (JPM) purchase of Bear Stearns (BSC). This LLC will receive $30 billion in assets from JPM as collateral for its loan, financed at the discount rate of 2.5%. "

    IS IT REALLY AN ADDITIONAL 29 B? Or is it the original 30B-1B now assumed by JPM?

    "This stinks as does the rest of this multi-billion deal where I am still looking for the actual cash involved. So far I can only see several layers of debt. Why is this portfolio valued at prices of April 14? What happened to realtime data? How much is this portfolio worth today?"

    GOOD QUESTION BUT HOW MUCH WOULD IT HAVE BEEN FURTHER DISCOUNTED IF THE FED AND JPM HAD NOT STEPED UP TO PREVENT A FINANCIAL MELT DOWN?

    According to the WSJ, taking it from the NY Times, JPM will now exchange 0.21753 shares for every Bear share, effectively quintupling the original offer of 0.05473 shares. No cash here.

    WOW DOES EVERY BUTOUT OFFER CARRY A CASH PORTION WITH THE OFFER ?



    "The offer was also sweetened with an issue of 95 million new Bear shares JPM will buy until April 8, giving it a 39.5% stake in outstanding shares. No mentioning of cash here either. "

    JPM IS PITTING UP CASH FOR SHARES ARE THEY NOT?

    "I also fail to understand what it means that the Fed will absorb the first billion of losses on the collateralized portfolio. Is this an effort to build trust that the Fed actually sees value in this portfolio? "

    READ THE ARTICLE AGAIN! JPM WILL ABSORB THE FIRST 1B OF LOSSES NOT THE FED!

    PISS POOR WRITE UP/ARTICLE THAT YOU HAVE PROVIDED .




  •  
    Genesis
    Mar 24 11:33 PM
    My Website
    Well from where I sit this is flatly unlawful.

    The Fed has specifically enumerated powers and limitations laid out in The Federal Reserve Act of 1913.

    Nowhere do I see the ability to provide what amounts to a bribe (the "backstop", or "no-recourse"... loan), nowhere do I see the right to establish fictional persons for the purpose of moving liabilities off balance sheet (the LLC), and on and on and on.

    And since Treasury and, if reports are believed, President Bush, signed off on this, they're complicit in a violation of their oaths of office.

    Ergo, its time for America to stand up.

    financialpetition.org does exactly that. It asks Congress to look into this cluster**** and determine if indeed the Constitution or law was violated and, if so, well, you know what comes next.
  •  
    acadia
    Mar 24 11:52 PM
    if the fed gov is going to save bear stearn with 1BL I like to see how
    they are going to save the USD from falling 25% by the end of this year.
  •  
    SD CDL
    Mar 28 12:18 PM
    Good article, its amazing how the "answer" is right in front of us but never looked into. When I talked to coworkers about the housing bubble they back it up to the players but never past the banks to who gives them the money, the Fed. I am seeing a sea change, though, in the realization that Greenspan was a bubble blower and Bernanke will follow suit. I'm waiting to see how the Fed will attempt to deflect criticism while the dollar crashes... Gold is crying "BS!" to the central banks around the globe. Jim Rogers was right, Ben should dissolve the Fed and resign (in theory, in practice would be a little harder)
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