Too Much to Bear
On March 14, the Federal Reserve took an extraordinary step to keep Bear Stearns Companies from collapsing. The Fed agreed to lend much-needed cash through JP Morgan Chase for up to 28 days. The funding was the largest-ever government bailout of a U.S. securities firm. The move showed how seriously the Fed believes the financial system is at risk.
Two days later, it was announced that JP Morgan Chase would buy Bear Stearns for $240 million or $2 a share. The weekend move all but wiped out $13 billion of market equity that was shown on November 30, the end of their fiscal year. Bear Sterns, founded in 1923, was once the largest underwriter of U.S. mortgage bonds. The company had survived the Great Depression and was considered a very savvy trader and investment firm.
Bear Stearns troubles became public last spring when two of its mortgage-related hedge funds developed problems and collapsed in July costing investors more than $1 billion. Confidence in the firm dropped two weeks ago as word spread that European banks had stopped trading with the firm. This caused traders to withdraw funds fearing that a bankruptcy would lock in their deposits.
Although the company denied its access to capital was at risk, it was, and the Fed intervened. As Mark Gertler of New York University put it, “The name of the game is preventing disaster. By letting one house burn down, you might have the whole neighborhood burn down.”
The real problem with the Fed’s unprecedented move is that bailouts tend to encourage and reward risky behavior. Bear Stearns was a major player in the sub-prime debacle. Bear’s management got the company into the mess that taxpayers were later being asked to shore it up. Those managers should, in the words of the Wall Street Journal, “Be fired, without bonuses and golden parachutes. If bankers believe they can make bad investments and still emerge with enough cash to buy another beach house, the financial system will never have enough discipline.”
No one wants to see others lose their investment. In the case of Bear Stearns, it was rumored that employees owned a third of the stock. Today they are wiped out. So is former Chairman James Cayne, who is reported to have lost $1 billion. Joseph Lewis, who bought 9.4 percent of Bear Stearsn last year, lost $1.16 billion. The investment firm of Morgan Stanley also lost $546 million, and the list goes on and on.
The likelihood is you will see more actions taken by the Fed and Treasury Department to stabilize markets and restore confidence in our financial institutions. This is acceptable given that the country is in a recession, the number of U.S. homeowners entering foreclosure rose 75 percent in 2007, and a very weak dollar has caused the price of imported oil to rise to levels that may bring a return of inflation. The economy is at risk.
Not withstanding the bleakness of today’s economy and moves by the Fed to restore confidence, it is still the responsibility of Wall Street managers to step up efforts to bolster their own capital and show the public what the quality of their assets are and what they are worth on their balance sheet. The problem with Wall Street’s investment firms is they are neither fish nor fowl. They are not commercial banks or insurance companies that undergo extensive yearly regulatory examinations. Companies like Bear Stearns are large trading firms and brokers whose business is built on trust. Bear Stearns had $400 billion in assets and 14,153 employees. When the trust goes, so goes the firm.
Most universities today have major coursework devoted to ethics. It is talked about and preached to the young, but is it practiced? Unfortunately, those running Wall Street cared only about themselves and what they got out of the day. There are many hurting financially today because of that attitude. It must be the first to change if confidence in the system is ever going to return.