Thursday
Apr032008
Fed called to answer for bailout of Bear Stearns
Why did you bail out Bear Stearns? It was the resounding question heard over and over in the Senate Banking, Housing, and Urban Affairs Committee hearing on "Turmoil in U.S. Credit Markets: Examining the Recent Actions of Federal Financial Regulators." Federal Reserve Chairman Ben Bernanke, SEC Chairman Christopher Cox, United States Treasury Under Secretary Robert Steel, and President of the Federal Reserve Bank of New York Timothy F. Geithner, all attempted to answer that question to Congress.
In his opening statement, Senator Chris Dodd (D-CT), said the stunning fall of Bear Stearns was matched only by the sweeping response to its collapse put together by the New York Fed and the Federal Reserve Board of Governors, which, with the support of Treasury, "exercised powers in some instances that had not been used since the Great Depression." However, he said, people on 'Main Street' are struggling to pay their mortgages, and so was the rescue of Bear Stearns justified to prevent a systemic collapse of financial markets, or was it a $30 billion taxpayer bailout for a firm on Wall Street?
Yes, but how big do you have to be, to be too big to fail? Senator Jim Bunning (R-KY) posed that question in his opening statement. Why, exactly, was it necessary to stop the invisible hand of the market? That is Socialism, he said, adding that he was very troubled by the failure of Bear Stearns. A big question, he said, was who let our financial system become so fragile?
Chairman Bernanke said the that pressures in the short-term bank funding markets have increased, and many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and they have increased the amount of collateral they required to back short-term security financing agreements. Credit availability is restricted, and some key securitization markets (including those for nonconforming mortgages) continue to function poorly if at all.
Bernanke, nearly at the end of his prepared statement, arrived to the explanation as to why they had assisted Bear Stearns. The news that Bear Stearns would have to file for bankruptcy, he said, raised difficult questions of public policy. "Normally, the market sorts out which companies survive and which fail, and that is as it should be. However, the issues raised here extended well beyond the fate of one company." He said that our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a range of "critical markets." The damage caused by a default by Bear Stearns "could have been severe and difficult to contain."
The chaotic unwinding of Bear Stearns could have cast doubt of the financial positions of some of Bear Stearns' thousands of counterparties, Chairman Cox said. But a question remained on whether or not investors were at risk. Despite the run on the bank to which Bear Stearns was subjected, Cox said, its customers were fully protected. At no time during the week of March 10-17th were any of the customers of the Bear Stearns's broker-dealers at risk of losing their cash or their securities.
Under Secretary Steel gave an explanation as to why Bear Stearns was assisted, saying a strong financial system is vitally important for all Americans. When our markets work, he said, people throughout our economy benefit, and when our financial system is under stress all Americans bear the consequences. The focus was more on the strategic concern of the implication of a bankruptcy. The failure of a firm that was connected to so many corners of the market would have caused financial disruptions beyond Wall Street.
The risk has its protections, Geithner said. There is a substantial pool of professionally-managed collateral that was valued at $30 billion, the agreement on the part of JPMorgan Chase to absorb the first $1 billion of any loss that ultimately occurs in connection with this arrangement, and a long-term horizon during which the collateral will be safe-kept.
In the written statement of James Dimon, Chairman and Chief Executive Officer of JPMorgan Chase, he said they got involved in the matter because the collapse had the potential to cause serious damage to the financial system. They could not, and would not have assumed the risks of acquiring Bear Stearns without the $30 billion facility provided by the Fed, and that the transaction is not without risk for JPMorgan. However, they informed the New York Fed and Treasury that the risks were too great for JPMorgan to buy the entire company on their own. The statement also explains the reason for bailing out Bear Stearns: a Bear Stearns bankruptcy could have touched off a chain reaction of defaults at other major financial institutions, and the consequences could have been disastrous.
The repeated phrase by each and every witness was that the failure of Bear Stearns was a result of a lack of confidence. According to the written statement of Alan Schwartz, President and CEO of the Bear Stearns Companies, even though the firm was adequately capitalized and had a substantial liquidity cushion, "Unfounded rumors and attendant speculation began circulating in the market" that Bear Stearns was in the midst of a liquidity crisis. The unfounded rumors grew into fear and there was a run on the bank.
In his opening statement, Senator Chris Dodd (D-CT), said the stunning fall of Bear Stearns was matched only by the sweeping response to its collapse put together by the New York Fed and the Federal Reserve Board of Governors, which, with the support of Treasury, "exercised powers in some instances that had not been used since the Great Depression." However, he said, people on 'Main Street' are struggling to pay their mortgages, and so was the rescue of Bear Stearns justified to prevent a systemic collapse of financial markets, or was it a $30 billion taxpayer bailout for a firm on Wall Street?
Yes, but how big do you have to be, to be too big to fail? Senator Jim Bunning (R-KY) posed that question in his opening statement. Why, exactly, was it necessary to stop the invisible hand of the market? That is Socialism, he said, adding that he was very troubled by the failure of Bear Stearns. A big question, he said, was who let our financial system become so fragile?
Chairman Bernanke said the that pressures in the short-term bank funding markets have increased, and many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and they have increased the amount of collateral they required to back short-term security financing agreements. Credit availability is restricted, and some key securitization markets (including those for nonconforming mortgages) continue to function poorly if at all.
Bernanke, nearly at the end of his prepared statement, arrived to the explanation as to why they had assisted Bear Stearns. The news that Bear Stearns would have to file for bankruptcy, he said, raised difficult questions of public policy. "Normally, the market sorts out which companies survive and which fail, and that is as it should be. However, the issues raised here extended well beyond the fate of one company." He said that our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a range of "critical markets." The damage caused by a default by Bear Stearns "could have been severe and difficult to contain."
The chaotic unwinding of Bear Stearns could have cast doubt of the financial positions of some of Bear Stearns' thousands of counterparties, Chairman Cox said. But a question remained on whether or not investors were at risk. Despite the run on the bank to which Bear Stearns was subjected, Cox said, its customers were fully protected. At no time during the week of March 10-17th were any of the customers of the Bear Stearns's broker-dealers at risk of losing their cash or their securities.
Under Secretary Steel gave an explanation as to why Bear Stearns was assisted, saying a strong financial system is vitally important for all Americans. When our markets work, he said, people throughout our economy benefit, and when our financial system is under stress all Americans bear the consequences. The focus was more on the strategic concern of the implication of a bankruptcy. The failure of a firm that was connected to so many corners of the market would have caused financial disruptions beyond Wall Street.
The risk has its protections, Geithner said. There is a substantial pool of professionally-managed collateral that was valued at $30 billion, the agreement on the part of JPMorgan Chase to absorb the first $1 billion of any loss that ultimately occurs in connection with this arrangement, and a long-term horizon during which the collateral will be safe-kept.
In the written statement of James Dimon, Chairman and Chief Executive Officer of JPMorgan Chase, he said they got involved in the matter because the collapse had the potential to cause serious damage to the financial system. They could not, and would not have assumed the risks of acquiring Bear Stearns without the $30 billion facility provided by the Fed, and that the transaction is not without risk for JPMorgan. However, they informed the New York Fed and Treasury that the risks were too great for JPMorgan to buy the entire company on their own. The statement also explains the reason for bailing out Bear Stearns: a Bear Stearns bankruptcy could have touched off a chain reaction of defaults at other major financial institutions, and the consequences could have been disastrous.
The repeated phrase by each and every witness was that the failure of Bear Stearns was a result of a lack of confidence. According to the written statement of Alan Schwartz, President and CEO of the Bear Stearns Companies, even though the firm was adequately capitalized and had a substantial liquidity cushion, "Unfounded rumors and attendant speculation began circulating in the market" that Bear Stearns was in the midst of a liquidity crisis. The unfounded rumors grew into fear and there was a run on the bank.
Greenspan: Regulating Banks Was A Failure
Billions of dollars used in the federal bailout of financial institutions was a mistake,said Former Federal Reserve Chairman Alan Greenspan today in D.C. Speaking at the American Enterprise Institute, Greenspan said that the ‘Too Big To Fail’ doctrine used by the Bush and Obama Administrations was seriously flawed.
“Earlier this decade,” said Greenspan, “it was widely expected that the next crisis would be triggered by the large and persistent US current-account deficit precipitating a collapse of the US dollar. The dollar accordingly came under heavy selling pressure” when the euro-dollar exchange rate rose starting in spring 2003.
“A financial crisis is characterized, in fact defined by an abrupt, discontinuous break in asset prices. But discontinuities are, of necessity, a surprise and that requires that the crisis be largely unanticipated by market participants. For, were it otherwise, financial arbiters would have diverted it,” said Greenspan.
In March, in light of the failure of Lehman Brothers and the rescue of AIG, Treasury Secretary Timothy Geithner proposed a plan to set a systemic regulator which would oversee the entire financial system and would prevent certain banks and nonbank financial firms to collapse financially. The plan would give the authority to the Federal Deposit Insurance Corporation the authority to bail out or liquidate failing banks or firms.
Greenspan said that “it is one thing to identify firms whose collapse might severely impair financial intermediation; it is quite another to identify institutions whose failure will lead to systemic breakdown. Systemic risk is readily identifiable. Potential systemic failure is not,” he said.
For Greenspan, the role of shareholders is important to explain the current financial crisis. “In Capitalist societies, we need shareholders to govern,” said Greenspan. “But their perspective has become increasingly that of investors, not owner-managers. When dissatisfied with corporate performance, they tend to sell their shares rather than seek to change management.”
“Of all the regulatory challenges that have emerged out of this crisis,” Greenspan views “the ‘too big to fail’ problem and its precedents, now fresh in everyone’s mind, is the most threatening to market efficiency and our economic future.”