The debt fueled bubble and the recession that followed

As we had often come back to discussing economic benefits/impact of sports I thought it was about time for an economic discussion forum.
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puneets
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The debt fueled bubble and the recession that followed

Postby puneets » Tue Mar 18, 2008 5:39 am

And now Bear Stearns is the latest (and the biggest) casualty of the present mortgage mess in the US market. All of a sudden, speculations are rife about other such IB which rely a lot on mortgage backed securities (Lehman ?).
I'd appreciate if someone (PKB :) ) could explain me (in a little more detail) the current mess.
Last edited by puneets on Tue Mar 18, 2008 5:45 am, edited 1 time in total.

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Re: Sub-prime crisis and Bear Stearns

Postby puneets » Wed Mar 19, 2008 4:56 am

no takers :(

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Re: Sub-prime crisis and Bear Stearns

Postby prasen9 » Wed Mar 19, 2008 5:05 am

The Fed comes in and says that it will backup Bear Stearns' liabilities if Chase buys it (or something to that effect).  So, the definition of "free market" is that when it comes to welfare, the government bailing out badly run companies is fine, but, the government bailing out individuals or allowing them to file bankruptcy against credit card companies is somehow allowing them to shirk their basic responsibilities and blasphemy (see the bankruptcy act).  If the government keeps bailing out these investment firms, why will they stop taking stupid risks?

Did someone say "regulatory capture" ..... ?

Dana Perino, when asked about this disparity, comes out and says that the consumers have got their piddly tax relief of $600 each, haven't they?  I guess they should just be happy that they are getting this instead of that sum also going to the "patriotic" oil companies.

For the record, I am against bailing out both individuals and companies who indulge in risky financial practices.

p.s. puneets, perhaps I have not explained the current mess or its reasons, but, why bother doing so instead of a good rant :-)
Last edited by prasen9 on Wed Mar 19, 2008 5:09 am, edited 1 time in total.

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Re: Sub-prime crisis and Bear Stearns

Postby PKBasu » Wed Mar 19, 2008 7:53 am

Bear Stearns was not bailed out by the Fed, as Bear Stearns' shares were sold to JPMorgan at US$2/share (versus a share price of over US$50/share at the start of trading on Friday morning and over $120/share six months ago). In effect, Bear Stearns' equity holders (including employees, who owned 30% of the bank) took a massive "hair-cut". A transaction in which the equity-holders (as well as the shareholdings of management and employees) are effectively wiped out cannot be called a "bail-out", it is simply a market-determined transaction between willing parties.
The one element of a "bail-out" here was the US$30bn of Bear Stearns' assets that the Fed agreed to take onto its books -- in order to forestall potential systemic risks from a disorderly fire-sale of those assets, which could have had serious ramifications in a myriad other asset markets. It is the systemic risks that justify the Fed's actions, and those risks were very real in this case.
Note that Bear Stearns' shareholders are now asking why the company could not simply have sought Chapter 11 bankruptcy protection -- the implication being that the company might have fetched a better price at the end of a bankruptcy process. However, the systemic risks might then have been exacerbated, as some of BSC's assets had already become completely illiquid, and would need to be sold off. There were clearly no takers for BSC over the weekend at any price (unless the Fed agreed to manage those $30bn of temporarily illiquid assets). The smooth functioning of the financial system is part of the Fed's responsibility, and its actions contributed to that outcome; had there been no systemic risks, BSC could have been allowed to continue operating independently, but the Fed concluded that option was no longer viable. To call this "corporate welfare" (when the guilty corporation's employees and management are taking a huge hit, being punished severely for their own AND system-wide mistakes) is inappropriate.

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Re: Sub-prime crisis and Bear Stearns

Postby puneets » Wed Mar 19, 2008 3:26 pm

Isn't Bear Sterans' real estate in midtown Manhattan (headquarters) worth more than twice the $2 per share valuation ? So does that mean that they have a lot of liabilities in their books ?

One thing that I'm unable to comprehend is the lack of other bidders for buying out Bear Stearns. If the Feds have already promised to underwrite the risks for BSC's assets, then why are the other big banks not stepping up in the ring in order to acquire BSC ?

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Re: Sub-prime crisis and Bear Stearns

Postby PKBasu » Wed Mar 19, 2008 5:21 pm

What happened to Bear Stearns was like a classic run on a bank: it was a consequence of the rest of the market's loss of confidence in BSC. Although the underlying assets may actually have value, in BSC's hands they are perceived to be nearly worthless. The same assets owned by JPMorgan will seem much more valuable -- and the break-up value of BSC (in JPMorgan Chase's hands) will be several multiples of what JPM paid.
As BSC's borrowings and other liabilities matured, others in the market were not willing to roll-over those liabilities. That made it difficult for BSC to function without attempting to sell off some of its assets. But a large fire-sale of assets could have had significant negative impact on asset prices across a wide swathe of the financial market, leading to a downward spiral for itself and perhaps for other major players in different markets in which BSC participates. Hence the need for a coordinated sale of the company; there were indeed no other takers, given the size of BSC. Only JPM is stable enough at this time to want to take on a company like BSC, but even JPM was obviously not entirely comfortable with US$30bn of BSC's assets, which have had to be underwritten by the Fed.

Rumour-driven markets and panic selling are toxic. We in Asia went through it in 1997, and it is instructive to see the world's largest economy going through it now. But the US has a few more options than, say, Indonesia had in 1997 because the greenback is the world's reserve currency, giving the Fed more monetary options than are available to almost anybody else.

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Re: Sub-prime crisis and Bear Stearns

Postby gbelday » Wed Mar 19, 2008 11:05 pm

Some of you probably know that I work for Bear Stearns (in their midtown building).  These past few days have been pretty rough.  I was working on Sunday helping my boss with the presentation that he was making to the JP guys.  I couldn't believe the price when it was announced but there are a lot of reasons for that. JP obviously wants a big "cushion" in case they see something majorly wrong with the books.

I am not really sure if JPM is interesed in our Equities business - I may be out of a job soon guys! More later (if anyone is interested).

BTW, in my opinion, PKB got it all right!  :notworthy:
Last edited by gbelday on Wed Mar 19, 2008 11:25 pm, edited 1 time in total.

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Re: Sub-prime crisis and Bear Stearns

Postby prasen9 » Wed Mar 19, 2008 11:19 pm

PKB, I understand that the government did not make a loan or buy out Bear and Stearns.  Perhaps our definitions of corporate welfare are different and I must say that I have nowhere near the understanding that you have about these matters.  However, the Fed did takeover BSC's dodgy portfolio.  The reason that you are giving (and from what I read it is perhaps valid) is that there is a risk of systemic damage, but, there was also a risk of recession, etc. when individuals were facing foreclosure left and right. 

So, I have two questions/comments:

1. Do you think this government would intervene similarly (or has intervened similarly) when individuals were in the same scenario?  If collectively, say 20% of the U.S. population own similar dodgy assets from risky investing, would the Fed come and assume their assets and try to sell it at a higher rate than they would get?

2. However, it is spinned, this is contrary to the unlimited free market and limited government principles that are propounded in this country by a certain faction of the government and the media.  Free market means the free market.  Why rail against government intervention to help individuals when you run to them to help out drowning companies?  A similar thing happened with the airline industry after 9/11.

My objection is not that these actions are not warranted, but, my objection is that what is there is a fairness question when the government intervenes when companies are involved but does not when individuals suffer.  I am sure someone will point out the so-called trickle down of wealth from companies to individuals, etc.

Here is what Paul Krugman has to say Krugman Opinion

-pm

p.s. Sorry, Gautam, I did not know that you work at BS.  Hopefully you will keep your job or get a good one quickly.
Last edited by prasen9 on Wed Mar 19, 2008 11:27 pm, edited 1 time in total.

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Re: Sub-prime crisis and Bear Stearns

Postby Kumar » Wed Mar 19, 2008 11:59 pm

Hi Gautam,
I hope it works out well for you.

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Re: Sub-prime crisis and Bear Stearns

Postby suresh » Thu Mar 20, 2008 12:48 am

Hi Gautam,
Keep your chin up. Good luck.
Suresh

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Re: Sub-prime crisis and Bear Stearns

Postby Peter » Fri Mar 21, 2008 5:14 pm

PK,  You are toeing the official line.  i have a seat reserved for you on the Fed board  :D

Why save BSC? (Apologies to Gautam.  Hope you do well regardless.)  Why let them, the greedy crooks (who were leveraged 32 to 1) who earned millions in bonuses with the ponzi scheme get away?  Isn't that what capitalism is all about? 

The Fed is socializing the losses instead.  And the world markets have woken up.  How much longer will the US $ be the world's 'reserve' currency?  Got pesos?  Or the soon-to-be announced Amero?  :D

On a related note.  Have you talked to Jim Rogers lately?


Support for BSC outrageous

[url=http://video.google.com/videoplay?docid=-6046520409389956642]Abolish the Fed
[/url]
-------------

Another one, this time from Paul Volcker, on the role of the Fed.  The main takeaway i got from this was why the brokerage houses need to be regulated (just as the banks are) if the Fed is planning on keeping them afloat.

Meanwhile back here in the US, inflation has accelerated:  Food, Gasoline and a good bicycle, all up ~20%  in the past 12 months (my estimate).  Don't believe the official US CPI.  It is all hedonics, smoke & mirrors.

Apologies if i come across as cynical on this post.  i am really an optimistic, happy kind of guy  :D
Last edited by Peter on Sat Mar 22, 2008 2:11 am, edited 1 time in total.

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Re: Sub-prime crisis and Bear Stearns

Postby Atithee » Fri Mar 21, 2008 5:56 pm

I have largely remained silent on this issue.  But the current Fed actions, and bailing BS being one of the worst acts of interference, are so irresponsible that our coming generations should never forgive us for letting this happen.  The yoyo nature of discount rate movement in the past five years is unprecedented and unwarranted (IMO).

Time will not look back kindly upon Fed and Bush Jr. (as if there was any doubt about the latter).  At least my conscience is clear -- I never voted for him either time!

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Re: Sub-prime crisis and Bear Stearns

Postby prasen9 » Fri Mar 21, 2008 8:44 pm

My snarkish posts aside (everything is modulo my limited understanding), what this action does is that it says that if you are big, then you can expect some help from the Fed to underwrite your risky assets in the worst case.  If I am a small business and buy a lemon car and are about to go bankrupt, will the Fed come in and back my lemon car with assurances?  The only reasoning I have heard is that they are choosing among the two evils and if this was not done then the markets would collapse (I am exaggerating a tad), or something like that.  Well, if you do what they did now, next time we have Citibank or Chase or some other investment banks think about risky portfolios, they will know that the Fed will cushion their worst-case scenario because they are *big*.  No bank wants to fail and get their stocks sold for $2 a share (or a better measure is the tiddly market cap at that price), so that is the biggest deterrent against taking unnecessary risks, but, this action gives a signal to big banks that you will not have to take *full* losses because the Fed cannot afford to let you completely tank and thus they may take on more risky ventures than the smaller fish.

-pm
Last edited by prasen9 on Fri Mar 21, 2008 10:27 pm, edited 1 time in total.

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Re: Sub-prime crisis and Bear Stearns

Postby BSharma » Fri Mar 21, 2008 9:08 pm

Good luck, Gautam.  You will always be in our prayers and thoughts.  Let me know if I can be of any help.

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Re: Sub-prime crisis and Bear Stearns

Postby prasen9 » Sat Mar 22, 2008 3:55 am

More opinion on BS & the Fed: Commentary.  At the very minimum the bailout should have come with meaningful regulation.  If our money will bail them out, then we need to have a say to prevent such behavior in the future.
Last edited by prasen9 on Sat Mar 22, 2008 3:58 am, edited 1 time in total.


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