Friday, March 14, 2008


about 100 years after jp morgan, the person, bailed out wall street, his bank is at it again. in a dramatic move today, the fed of ny and jpm made emergency funding available to bsc after other market players lost confidence in the beleaguered investment bank as a trading partner. as the credit crunch has deepened and broadened, the worst fear of many on the street has been the collapse or forced rescue of a big bank or broker.

jpm is bsc's clearing bank and will act as a conduit for fed funding. in a special vote, the central bank’s governors chose to allow jpm to bring collateral from bear, including mortgage assets, to the fed discount window in return for 28-day loans. bear does not have direct access to the window because it is not a depository institution. the fed has agreed not to hold jpm liable for any losses on the collateral posted. the central bank has resorted to such an arrangement only twice before, in the depression of the 1930s and in the 1960s.

the meltdown at bsc, which began last summer when two of its hedge funds blew up, is a classic example of how liquidity problems and ebbing confidence can quickly turn into a solvency crisis, especially for investment banks, which are more reliant on short-term funding than commercial banks. bear has spent much of the last year strengthening its funding structure. but in the past week doubts grew over its ability to meet its obligations. other banks refused to step in as counterparties to bsc in credit-derivatives contracts. bear's boss, alan schwartz, admitted that his bank had struggled to dispel rumours and “parse fact from fiction”, and that its liquidity position was thus deteriorating at an alarming pace.

bear’s shares initially jumped on news of the bail-out but crashed after the market opened today. at one point, half of its market value had been wiped out—an unprecedented one-day fall for a big wall street firm in modern times. according to reports, clients were desperately trying to pull assets out of bear today. but the bank insisted that its capital ratios remained strong. in fact, some say its book value is still somewhere in the 80s (the stock's at about 30 now).

bsc would have failed today without the action by the fed and jpm. the timing of the move shows desperation on bsc's part. reports are everywhere that the firm is shopping itself like mad. if it could have held on until 3/27, it would have been able to borrow directly from the central bank under a new facility announced earlier this week.

though bsc is the smallest of the “big five” wall street investment banks, it is the most exposed to credit markets, particularly mortgages, relative to its size. its larger peers can take comfort in being more diversified, but they too are largely at the mercy of short-term funding markets and the confidence of counterparties. others may be losing sleep, too. will bear's woes only exacerbate worries about highly-leveraged hedge funds, an increasing number of which are finding it hard to stay afloat as their prime brokers jack up margin calls? a fund affiliated with carlyle group, a big private-equity firm, crashed this week.

bear’s fate now hangs in the balance. it said today that it was in talks with jpm over “permanent” financing, but that there could be “no assurance that any strategic alternatives will be successfully completed”—a possible reference to a takeover. in my opinion, a takeover - or takeunder - is by far the most likely scenario. again, bsc has been reportedly shopping itself to competitors with the help of another bank. the fed and other regulators will presumably work hard to ensure that bear ends up under the wing of a stronger rival.

but would-be buyers undoubtedly are wary. bsc's books are stuffed with complex “structured” mortgage-related assets, the value of which is hard to calculate at this moment in time. as a result, so is the value of bear’s equity. a full-blown collapse cannot be ruled out if the value of its collateral continues to fall.

ironically, the intervention came a day after S and P, a rating agency, said that the worst of banks’ write-downs related to subprime mortgages — bear’s biggest weakness—may soon be over. but if the extraordinary events of the past day demonstrate anything, it is that investment banks are black boxes, and what really matters is not what sits in them but what their counterparties fear may be lurking inside.

long gs, jpm

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