The Bear Stearns debacle last Friday opened the “what if” Pandora’s Box on the investment banking industry, and the possibility for a full fledged financial market meltdown. The Fed stepped up in unexpected, yet true white knight fashion to forestall for the moment anyway, such economic destruction. Now Congress and the Treasury must do the same for the longer term.
Hats off to Fed Chairman Ben Bernanke and the Fed for not only promptly intervening, but too with none of the usual bureaucratic red tape, leading the bailout or buyout depending on one’s perspective of Bear Stearns. In fact, ring fencing potential global financial market contagion from the event. The genesis of this debacle being Bear Stearns heavy involvement in the mortgage back security and related sub-prime credit markets. To be clear, the Fed’s intervention prevents a complete stock market collapse, not a painful decline.
Too, the Fed solution generated being a uniquely innovative one at that. One which cleverly and legally bypassed the inability of Bear Stearns to directly access the Fed discount window. That unique new investment banking access facility to the Fed discount window now in place for a minimum of six months to allow other investment banks direct access as need be, as the crisis is attacked and weathered. In achieving this, the Fed is using an entity that can access the window in legitimate and legal fashion, itself then acting as a conduit to get the necessary resource funding to Bear Stearns. That middle man (and MAJOR beneficiary) being JP Morgan Chase. With this new access, the investment banking industry will never be the same again - a good thing.
Consider then the Fed action on Bear Stearns as Step 1, which temporarily stems the bank run crisis. In effect, buying much needed time to create a broader, long term industry confidence building solution.
The question or rather assumption then is that Bear Stearns may be the tip of the iceberg. If so, then what is that broader Step 2 necessary to end the crisis not only at Bear Stearns but in the aggregate longer term for the industry, to preclude a domino like financial institution meltdown, as now is evidently indeed possible?
Quite simply, backstop the other potential “bank run” candidates like Lehman Brothers, Merrill Lynch etc. etc.
The key Bear Stearns and broader industry issue here is not not being able to meet transaction commitments during normal business flow. Rather, can they meet abnormal demand, such as a “run” when everyone all at once wants out. In fact, that “run” either generated from or leading to a loss of confidence by customers in Bear Stearns and others to honor their commitments.
The problem is these entities are highly leveraged, and can’t meet everyone’s liquidation request at the same time, as what apparently happened with Bear Stearns last Thursday, just 24 hours after it said its capital situation was fine. A statement presumably true if based on Bear Stearns capital situation at the time being able to continue meeting normal transaction demand. Unfortunately, the “run” started shortly thereafter, creating the unexpected overnight crisis.
At issue is what the industry calls a “Crisis in Confidence”. These entities survive and buttress the entire financial system with their core asset – confidence. Once investors lose that, a chain reaction “run” can ensue, with potential to bring the entire financial system down in domino-like fashion. The Fed in true watchdog fashion, immediately saw this threat becoming reality evident by its quick reaction to temporarily at least, prevent such a catastrophic system collapse.
Mr. Bernanke is doing his part to buttress the confidence in Bear Stearns in the short term. The next question is “What else can be done to backstop Bear Stearns and the others in the longer term to restore shattered “industry confidence” and restore normal financial market operation?”.
The answer is a meaningful industry backstop in the $100-200 billion range. Just so happens there is precisely that amount of funds “readily available”, yet on the precipice of being completely wasted and flushed down the toilet in the $150 billion economic stimulus package just approved by Congress.
Here we have an opportunity and funds readily available (if redirected) to backstop the entire financial market system. Vitally important because if the system collapsed, wiping out “trillions” if not “tens of trillions” of dollars in equity and other asset values, one could expect a Depressionary type reaction in the stock market and economy. Note the combined NYSE and NASDAQ equity valuations being approx. $21 trillion ($16 trillion NYSE and $5 trillion NASDAQ). Then add in the accompanying devastating losses in other major consumer assets – home values, etc., and the sheer scope of the potential devastation becomes all to apparent.
Here the U.S. sits ready to just fritter and give away $150 billion and reap no benefit whatsoever. In fact, do more harm than good, that before even considering the credit crisis issue.
Now looking at the latter, it could instead be used to save the loss of $10 trillion dollars or much much more. It’s really a no brainer what should be done with the stimulus funds, but then again we’re dealing with Congress.
A few specific thoughts on the “Economic Stimulus Plan” to make the point it’s a complete and total waste of precious taxpayer resources. In fact, it does not even pass the “Botox test”. Botox at least provides a brief, artificial and superficial improvement, which quickly disappears as if it never happened. Indeed, it’s akin to costly “no benefit” self indulgement. The Stimulus, on the other hand, won’t even provide immediate superficial improvement, given it stimulates China, not the U.S. (see “Which Economy?” below). In fact it becomes nothing but a “Placebo shot” to the U.S. economy.
Contrary to the Chicken Little economist and investment communities, mild recessions are not all bad and are actually long term quite beneficial as they create opportunities for important awareness and needed direction/course adjustments in an environment of little pain. If one believes the U.S. is already well into one, then all the hoopla in Washington and the press about an economic stimulus package is for naught. This is not a deep, two year recession situation. At worst, it will be brief and mild, however, counter-intuitively, slightly exacerbated “because” of the perceived stimulus messaging (i.e. things are worse than they seem) by the consumer.