With Paulson out today saying the government will do "what it takes", this raised the other side of the risk to shorting these names as the natural order of things is not being allowed to play out. That said, the open question is, with 5:1, 10:1, 20:1 and even 30:1 leverage in our entire shadow banking system, is this problem to big for the government? Already the Federal Reserve has used half its balance sheet to prop us up so far. Granted they have UNLIMITED balance sheet in theory as they can bring more dollars but do we risk hyperinflation to keep the financial system from its knees. Again, we've been talking about these issues for a long time... but to watch the dominoes begin to fall.... all I can say is these are unprecedented and truly fascinating times. I keep using the word "web" - this is a web of credit globally and when one falls it has implications worldwide. This is why I am not sure they can allow almost any major player to fall - because the implications will be unknown. Much like the Plunge Protection Team (in my opinion) engineered a private buyout of Countrywide Financial (CFC) as it was about to fall off the cliff into insolvency, I expect Bear Stearns to be "bought" (meaning any losses the Federal Government will take care of behind the scenes) very soon (and the market will rally of course)... but once again if a crisis of confidence truly erupts there will be more Bear Stearns - soon we will run out of banks to buy other financial institutions...
- Credit turmoil spread to the heart of the U.S. financial system as Bear Stearns Cos., an 85-year-old institution that has survived the Depression and World War II, sought and received emergency funding backed by the federal government. In an extraordinary move, the Federal Reserve and J.P. Morgan Chase & Co. stepped in to keep Bear afloat following a severe cash crunch. The lifeline gives Bear access to cash for an initial period of 28 days. J.P. Morgan will borrow the money from the Fed and relend it to Bear. Exact terms weren't disclosed, but the amount is limited only by how much collateral Bear can provide, Fed officials said. (effectively the worst of the worst toxic loans is now on the federal balance sheets, and you - the taxpayer - now bear the risk)
- The Fed, not J.P. Morgan, is bearing the risk of the loan. It is the first time since the Great Depression that the Fed has lent in this fashion to any entity other than a bank.
- Some Wall Street executives said they thought Bear was likely to be sold, in whole or piecemeal, in a matter of days, to prevent it from going under.
- Possible buyers, according to a person close to Bear, include J.P. Morgan and hedge fund Citadel Investment Group, which recently bought a big stake in online brokerage firm E*Trade Financial Corp. (Citadel is quickly turning into the next Goldman Sachs, an omnipresent financial powerhouse with its hands in everything)
- After initial relief, credit markets have taken a turn for the worse in recent weeks, breeding an every-man-for-himself attitude among Wall Street firms. With each firm intricately intertwined with others in a maze of loans, credit lines, derivatives and swaps, the Fed and Treasury agreed that letting Bear Stearns collapse quickly was a risk not worth taking, because the consequences were simply unknowable.
- Bear's situation echoed in some ways that at British mortgage lender Northern Rock PLC, which in September became the target of the U.K.'s first bank run in more than a century, after the Bank of England stepped in with an emergency line of credit. "At Northern Rock, it was depositors running. At Bear Stearns, it was counterparties" -- the parties a financial firm trades with -- said Tim Bond, a Barclays Capital strategist.
- Word began to spread among fixed-income traders nine days ago that European banks had stopped trading with Bear. Some U.S. fixed-income and stock traders began doing the same on Monday, pulling their cash from Bear for fear it could get locked up if there was a bankruptcy. That development put firms that still wanted to do business with Bear in a tough position: If Bear did fail, they would have to explain to their clients why they ignored the rumors. On Tuesday, a major asset-management company stopped trading with Bear.
- But by Thursday afternoon, it was becoming clear within Bear that the firm couldn't withstand an accelerating retreat by worried customers -- in effect, a run on the bank. Securities firms that had been willing to accept collateral from Bear Stearns were insisting on cash instead. And the hedge funds that use Bear to borrow money and clear trades were withdrawing cash from their accounts. Around 4:30 p.m., Mr. Schwartz was convinced that Bear was facing a desperate situation.
- Some time after 6 p.m., Mr. Schwartz called James Dimon, CEO of J.P. Morgan, the second-largest U.S. bank in stock-market value. J.P. Morgan's risk officers were familiar with Bear's collateral because J.P. Morgan was the clearing agent for its trades; thus, J.P. Morgan seemed to be in good position to lend Bear money, say people familiar with Mr. Schwartz's thinking. Mr. Dimon sprang into action. He got on the phone with Steve Black, co-head of J.P. Morgan's investment bank, on vacation in the Caribbean. The group had a number of conversations with Fed representatives, concluding that something needed to be done for Bear, in part because a failure of the firm could have wide consequences
- The Fed can lend directly through its "discount window," but ordinarily only to commercial banks. A 1932 provision of the Federal Reserve Act allows the Fed to lend to non-banks if at least five of its seven governors approve. That provision was last regularly used during the Great Depression. It is meant to underscore that the central bank should lend to nonbanks only in extreme circumstances. The Fed, with two governors' seats vacant and one governor overseas and unreachable, invoked a special legal clause to approve the loan with just four governors.
- For Fed officials it was a difficult choice. They did not want to single Bear out for help and they realized their actions aggravated "moral hazard" -- the tendency of bailouts to encourage future risky behavior. But the alternative was potentially far worse. Bear risked defaulting on extensive "repo" loans, in which it pledges securities as collateral for overnight loans from money-market funds. If that happened, other securities dealers would see access to repo loans become more restrictive. The pledged securities behind those loans could be dumped in a fire sale, deepening the plunge in securities prices.
- If Bear fails and the collateral it posts is insufficient to cover the loan, the Fed will sustain a loss. Officials say there is no preset maximum amount of the loan, other than how much collateral Bear is able to provide to meet the Fed's requirements.
Mr. Cayne dialed in from Detroit, where he was playing in a bridge tournament, say people familiar with the matter.
So in the end who is going to end up a big winner here, especially if another of the "big 5" go out of business? You guessed it - the company with men in every major financial post in America - Goldman Sachs.
