Wall Street as Black Hole

Originally published at the Washington Independent

Stock markets rebounded mightily yesterday, dazzled by yet more center-stage virtuoso turns by Federal Reserve Chairman Ben S. Bernanke. Over the weekend, he out-Greenspanned Greenspan by engineering a takeover of Bear Stearns, and then opened the Fed's resources to investment banks in addition to the commercial banks that are its normal constituency. Tuesday he cut the Fed fund rate target, or the bank funding rate, to only 2.25 percent, a full 3 percent rate cut since the fall.

(Matt Mahurin) Surely now, with crises once more brilliantly contained and Fed money flowing freely, consumers will get back to borrowing and buying, housing markets will stabilize and the economy will turn smartly upward.

Not a chance. The Fed has now committed all the ammunition it has to prop up Wall Street, and shore up shaky mortgages. All that's left in its trick-bag is to turn on a Weimar-style printing press.

With all the attention focused on the Fed, investors may not have noticed that the so-called Government-Sponsored Entities, (GSEs) Fannie Mae, Freddie Mac and the utterly obscure Federal Home Loan Bank, have been pouring even more money than the Fed into housing, with little effect. The mortgage mess, it now appears, is a black hole that can swallow up the Fed without a trace.

Consider the sequence of events during the Bear Stearns takeover negotiation over the weekend, as participants have described them to the media. JP Morgan Chase apparently came into the Saturday session expecting to do a deal in realm of $10-$12 a share, without any guarantees from the Fed. Bear, after all, owns lucrative low-risk businesses like stock-clearing, plus a trophy Skidmore, Owings building in midtown Manhattan. The equity in the building is worth at least $6 a share by itself.

Then JP Morgan looked at Bear's books and had a drastic change of heart. The deal was finally done only after Morgan's price was cut to $2 a share, or $236 million, and the Fed ponied up a line of credit of $30 billion (that's 'billion' with a 'b') to cover potential losses. Morgan, that is, got the entire company for less than 1 percent of the total investment, while accepting almost no risk until all of the Fed's $30 billion is burnt through.

What made Morgan demand such terms, and why would the Fed agree? Or to rephrase the question, what did the Morgan executives see on Bear's balance sheet that made them so terrified?

Bear's published balance sheet is perfectly standard -- tradable assets are mostly liquid corporate stocks and bonds -- except for a $46 billion dollar slug of mortgage-backed securities. The only evidence that they're worth $46 billion is that Bear Stearns said so. But they are almost all opaque strips of the same kind of 'CDOs' and other "structured securities," that have brought Citigroup, Merrill Lynch and UBS to grief. As Bear explains in the fine print, you have to value them partly or wholly with sophisticated internal models because their values are difficult to tie closely, if at all, to "observable" market data.

The obvious inference is that Morgan looked at those securities with its own models and said, "Hell no." Even Bernanke's -- or the taxpayers' -- $30-billion deal sweetener must not have fully covered the risk in Morgan's eyes, or the stock price wouldn't have been cut so drastically.

According to the widely accepted calculations of intrepid Fed-watcher and blogger Steve Randy Waldman, the Fed can plow, at most, $400 billion into Wall Street balance sheets. After last weekend, they've already used up $90 billion of it. In the second half of 2007, however, the three housing GSEs poured more than $600 billion in new money into the mortgage markets, obviously without "fixing" the problem. In the third quarter, when GSE financing peaked, according to analysts at BNP Paribas, it was equivalent on an annualized basis to 15 percent of GDP.

The huge volume of GSE financing, of course, has begun to push up the cost of GSE borrowing, despite the winks and nods from the Treasury and the Fed that this is really federal debt. Congress and the Bush administration, in the meantime, are working on legislation that will raise GSE borrowing limits and allow it to lend on lower-grade paper.

If you're into housing bubbles, the thinking seems to be, you might as well make it a really big one - like a dirigible. We could call it the Hindenberg.

Comments

[Rule Of Law]

I read an article that said B/S was loathed for their arrogance (considering the competition, they must have really been something) and they had no friends (meaning political clout) at the Fed. Thrown under the bus by the Fed to make good copy in their "battle to bolster the economy!" This buyout/bailout is proof that these masters of the universe eat their own. Paybacks a bitch, but easy to exact when using our money!

[joebhed]

A couple of days ago, just before closing down my computer to go on a family trip, I posted my comment - all that borrowing.
Today, re-reading the commentary and following it's excellent links, I see an additional dialogue not only further edifying on the nature of the problem, but discussing something that needs to get more ink.
Nationalize the failing banks.
First, to propriety.
I have written elsewhere that it is because the investment banks "cut-and-diced" financial securities in ways to make them incomprehensible to even studious obsrvers of the financial service industry, we lost out on any meaningful ability to properly value those securities.
And, because of the co-mingling and interconnectedness between the financial institutions holding those new "things", we can not allow any of those players to fail.
My opinion is this. Precisely because they set themselves up to drag down the entire national economy, if not the global economy, in the event they should fail, they should be seen as having set themselves up to be taken over by national government.
There should be no market player anywhere who can structure a system that holds a nation hostage to its pursuit of making money. None.
Now, most discussion involves the nationalization BY the FED in light of its receipt of support from the Treasury.
A reminder.
The FED, as we know it, is a private corporation.
Therefore, it is time to look beyond the FED as doing anything beyond being an intermediary vehicle to shore up the failing banks until such time as a true government entity can step in and establish a presence in this situation.
Yes, nationalize any bank that is too big to fail when the underlying structural parameters that would cause it to fail have been created by the banks in question.
The sovereign National Bank of the United States - or whatever we want to cal it.
Only the true deep resource of the United States taxpayer can stand behind any entity that can lead to a softer landing for our economy, and for our people.
Andthe Constitution so provides.
Only the Css can create that money that comes into being by action of the Treasury.
Only the Congress - a group acting of, by and for the people.
Nationalize the banks.
Let's get on with it.

[dadw5boys]

THEY WANTED DE - REGULATION !!!!!!!

THEY GOT IT!!!!!!!!!!!!!

Let them die with their investments just like the poor people they screwed!!!­!!!!!!!!!!­!!

[Sundialsvc4]

Charles, your reference to "Weimar on the brink" is extremely apropos, because that is precisely what we are dealing with here... only with computers. Money as a shell-game.

The next Federal budget is $2 Trillion? "Sure! No problem!" A government "borrowing from itself" to the tune of about $96,000 per second? "Sure! No problem!" But why is it "no problem?" Well, it dates back to when our dear man Henry Kissinger walked out of a Saudi palace with a great big grin on his face, certain that he had accomplished something truly historic. (I wonder what he thinks of it now, because he's lived to see its conclusion­.)

No more would the American dollar be tied to gold: it would ostensibly be tied to something far more valuable and desirable: Oil.

And with this "magic money machine," America began to completely dismantle itself, sure that a nation of more than 320 million people could just "buy what it needs and build what it wants," which turned out to mostly be weapons-systems. When you've got a money-machine, you don't need to produce. You can just jump right out the window, and fly.

The utter absurdity of trying to run such an economy on a 10,000-mile long supply chain seems to have been lost on them ... but it hasn't been lost on our shrewd enemies, who as of late seem to be exhibiting a certain disaffection towards our imperialistic ambitions. . . . .

Nevertheless, and ironically, real opportunity really is there! America has dormant industrial capacity, enough to have won World War II, right there among its consumers. This is probably what the savvy foreign investors want to own. When and if the American economy does start-up for itself, i.e. before or after the meltdown, it will now find itself attached to hoses pumping the cash back out of the country.

[MilwaukeeDan]

sundial, I'm with you. Peter www.europac.netpac.net) is someone I have been following for quite some time. He also asks, how long is the third world going to continue to finance out lifestyle? What is our dollar realy worth? The Chinese are not our allies, but they prop us up due to our great consumption, but they are always expanding to new markets. How long will they need us? They are all over Eastern Europe already. The Russians, Chinese, Indians and a host of others are making their moves, while we shoot our load "fitn terrr" and destroying what is left of our once great country.

[MilwaukeeDan]

sundial, Americans don't realize that Asia is rising. China and Russia are cooperating militarily and economically, they are as you say "shrewd enemies" of the USA. As for the "dormant industrial capacity" you refer to, much of it has been bulldozed. Most of the steel producers in this area(Chicago to Milwaukee) left or were closed and bulldozed years ago.

[WIpatriot]

Sundial, to answer one of your questions, you can bet that Kissinger today is chuckling and moistening his pants. Why he is not behind bars is indicative of the criminal cabal running the world.

[Henry]

If Bear has $46 billion of assets that are mbs, then it is likely that the underlying collateral that secures this asset are some 100,000 single family homes. Let's say that 30% of those assets, some 33000 home loans default. What time frame and expense does it take to convert those defaults into cash? I think it can be stated that from the time of default until the eventual reo (real estate owned) sale 12 to 24 months will pass. Legal expenses are incurred, real estate tax holding expense, maintenance and utility expense, appraisal expense, and then the eventual selling expense. You will not know these expenses, writ large, until you endure them. Add to this the sum total effect of "decrease" to home value because of increased sales and you have a hole in the collateral that can not be estimated. And the biggest problem here is that many to most of the people who were in subprime loans did not qualify, i.e. they had no "demand" for housing. So... there exists this inherent supply demand problem with supply increased (by building) and demand reducing (by more selective criteria for applicants) and an informed purchaser of the Bear looks at himself as a salvage man. What I describe for you is the reason that these mbs securities cannot be valued. (and this does not even consider the tranches). Imagine yourself as a due diligence employee for JPMorgan trying to assess the value of Bear assets? The proof, as they say, will be in the pudding. Frankly, I am surprised that Haliburton did not take the deal. You know, cost plus, single bidder? The Bushwa brand of bidness.

[LeftRight]

You are correct, and that is the problem with the bear stearns sale. This is why jpmorgan refused to do it, even though they were only expending some $300 million to buy it....

[PacificGatePost]

Tax payers are footing a bill on the Bear deal with significant downside and no upside.

While every tax payer is tightening the belt, just a little more, how about a show of good faith from the top of the economic food chain.... clean up the boardroom and get oversight back again.

There are numerous repairs needed to a system that by any account is failing.

"WE THE SHAREHOLDERS OF YOUR COMPANIES.­..... >>
http://pacificgatepost.blogspot.com/2008/03/letter-to-ceos-of-fortune-1000-cos.html


Shareholders, tax payers and employees are holding their breaths in anticipation of a resurgence of due diligence, oversight and good governance, in ALL BOARDROOMS.

[LeftRight]

Thus the reason that I said more than a year ago that when this hit we needed to batten down the hatches, and let it blow over. Of course Bernanke and bushco(tm) know better than I do, so they insisted on increasing inflation to near record levels (once it's all said and done!) WHILE at the same time doing absolutely NOTHING to stop the slide!!

[joebhed]

All that borrowing.