Bailout to Bailout - The Collapse and Rescue of Bear Stearns

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

By March 10, 2008, rumors were flying everywhere on Wall Street that Bear Stearns was in trouble. In an attempt to counter these rumors, Bear's CEO released a statement to the press that the company had a sufficient liquidity cushion to weather the credit crisis. When a company is going under, it has no choice except to make such claims. Instead of being reassuring, this type of statement is an indication of serious trouble. After all, a sound company has no need to assure the public that its financial position is strong - and Bear Stearns was no exception. Insiders, of course, are not fooled by these proclamations, which are meant for the average investor. Indeed examination of options activity during Bear's last days shows heavy put buying that quickly turned into huge profits for those in the know.

According to an SEC report released the following week, Bear Stearns had a cash shortfall starting on March 11th, only one day after the CEO assured the public that Bear had sufficient liquidity. By the evening of March 13th, Bear was no longer a viable business and behind the scenes it was already working out the details of a bailout plan with the Fed. Ironically, if indeed it was a coincidence, earlier that day, S&P released a cheer-leading report heralding the end to subprime crisis write offs, which in turn led to a strong rally in U.S. financial stocks.

On Friday the 14th, Bear Stearns stock went into free fall. It closed at $30 a share, down from a high of over $171 at its peak in January 2007. Depending on the source, the book value for the company's stock was somewhere between $84 and $97 a share. The market obviously didn't agree and it would turn out the Fed's judgment was even more pessimistic. Nevertheless, after the close, the CEO stated in a conference call with investors that the book value was fundamentally unchanged. He also claimed that Bear's 'liquidity position had markedly deteriorated because of market rumors' indicating that management incompetence, the reporting of misleading financial figures, or that Bear actually being insolvent had nothing to do with the loss of faith in the company.

The CEO also announced an emergency 28-day loan from the U.S. Federal Reserve. The Fed had no real legal authority to assist Bear Stearns, so it funnelled the loan through JP Morgan, one of its member institutions. It justified its actions based on an obscure 1930s law that gives the Fed broad ability to grant loans to corporations in crisis conditions. During the weekend, the Fed would became even more proactive and Bear Stearns was no longer be an independent company when the markets opened again on Monday morning.

NEXT: Bailout to Bailout - The Bear Bailout and Its Aftermath

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

What Banks and Enron Had in Common

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The Subprime Crisis began to take a serious toll on bank and broker earnings by the third quarter of 2007. Merrill Lynch led the pack with a $8.4 billion dollar write down. Citibank reduced its earnings by $5.9 billion, UBS by $3.4 billion, and JP Morgan by $3.1 billion. Deutsche Banks had $3.1 billion in write downs, but still amazingly managed to post a rise in earnings (one wonders who did their accounting). There was of course a lot of chatter from the talking heads in the media about whether or not these write downs were the final word in the impact of the Subprime Crisis on financial company earnings. Even the most casual knowledge of stock market history would have provided the answer - 'no they were not!' Whenever earnings in a group of stocks start to fall apart, the first write downs are never the last and usually aren't even the biggest for that matter. This was the pattern when the tech bubble burst only a few years earlier and yet many media commentators couldn't seem to remember even that far back.
Even without a knowledge of history, there was more than enough evidence to indicate that financial company write offs might get much bigger and go on for a long time. SIVs - structured investment vehicles - had already hit the news many weeks before November of 2007. These off-balance sheet items (think Enron) were so obscure that most people on Wall Street had never heard of them. Suddenly, there were an extra $400 billion of possibly bad debt that was not on the balance sheet of the banks, but would be winding up there eventually. Citibank alone had $100 billion in credit exposure to SIVs. This new wrinkle in the Subprime Crisis was viewed as so serious by the U.S. Treasury Secretary that he attempted to organize a bailout (how he had the authority to do so is unclear) by getting a number of large banks and brokers to create a pool that could buy up SIV assets and thereby support their prices. While much ballyhooed by the press, this effort went nowhere and was eventually abandoned by December.

While the Treasury Department's plans for SIVs fell through, the Federal Reserve created an alternative that could help out the big banks. It allowed them to borrow against their (highly questionable) assets, but this necessitated bringing the assets onto the books. In December, Citibank indeed brought $49 billion in SIV assets onto it balance sheet. It is presumed that the other $51 billion the Citi had originally in SIVs had disappeared because of reductions in value. Indeed, it was reported in December that the total value of SIVs was then only $298 billion (it was quite possible that even this was a significant overstatement of their actual worth). If Citi had lost approximate $50 billion in its SIV investments, it was not fully (if at all) reflected in write offs in its first quarter 2008 earnings report.

Although SIVs were considered a serious threat to the stability of the banking system, little did the public know in the fall of 2007, that they were not the sum total of all off-balance sheet items that the banks were holding. After all, why would a company have off-balance sheet items unless it wanted to hide what it was really doing? Since there purpose is secrecy, how does anyone know how many off-balance sheet items a company has, what assets they contain, and how much those assets are really worth? While it would be reasonable to assume that if there was one type of off-balance sheet item on a companies books, there could easily be others, there was little if any speculation on this matter by the financial media. Only in February of 2008 was it reported that SIVs were actually only one type of off-balance sheet items held by the banks - and the possible losses were much greater than had been previously imagined. The accountants who did Enron's book must have been envious.

Next: Mortgage Insurer Meltdown.

Daryl Montgomery
Organizer, New York Investing meetup

For more information about us, please see our web site: http://investing.meetup.com/21.