Sunday, January 10, 2010

Alternate history of the sub-prime crisis?

Did the US Government trigger off the sub-prime crisis to burst with the devastating consequences that followed, due to its dramatic decision of March 2008 to bailout the not-so-big-to-fail, non-depositary, securities trading firm, Bear Stearns, instead of letting it be liquidated or taken over by a healthier competitor? After a $30 bn Fed credit line (issued through JP Morgan) failed to satisfy the markets, Bear was sold to JP Morgan in an arrangement where Fed undewrote $29 billion in losses on $30 billion of Bear’s assets that JPMorgan refused.

William Cohan has a stinging indictment of those repsonsible, "Committee to Save the World 2.0" - Henry Paulson, Treasury Secretary; Ben Bernanke, Federal Reserve Chairman; and Tim Geithner, President of the New York Federal Reserve.

"By arranging for Bear’s shareholders to get a tip — it turned out to be $10 a share in JPMorganChase stock at the time (worth around $9 a share these days, based on JPMorgan’s recent stock price) — and for Bear’s creditors to get 100 cents on the dollar for what was a bankrupt company (where creditors would likely fight for years over the carcass), these three men single-handedly sent to the market a powerful message it would all too quickly misinterpret, much to our collective peril: For the first time in the history of American capitalism, the federal government would not let a big Wall Street securities firm fail.

As painful as it may have been at that time, the Committee to Save the World, Version 2.0, could have just as easily sent a very different message, one sent to the shareholders and creditors of poorly managed companies all the time: Too bad. You took risks you didn’t understand? Got too greedy? Took your eye off the ball? Kept in place executives and their cronies on the board of directors who should have retired or been replaced years earlier? Well, then, you are about to learn the valuable lesson of American capitalism and what it means to take stupid risks with other people’s money. You will lose your investments, your jobs and your company. Sorry about that. Stuff happens. The market understands that message loud and clear...

In retrospect, had Bear been allowed to fail and then been liquidated, the rest of Wall Street would have immediately come to grips with the seriousness of the situation instead of dallying for six months while thinking the Feds would step in and save them, too. Chances are Lehman rather than Bear would now be part of JPMorgan; Bank of America would likely still have bought Merrill Lynch. Morgan Stanley and Goldman Sachs would probably have just skated by with their investments from Mitsubishi and Warren Buffett, respectively."


To rephrase Alan Blinder's alternate economic history of the world - "if derivatives were traded on organized exchanges, if leverage were far lower, if subprime lending were smaller and done responsibly, if strong actions to limit foreclosures were taken right away, if Bear was allowed to fail, and if the TARP funds were used as directed"!

But then as Margaret Thatcher famously said, "The wisdom of hindsight, so useful to historians and indeed to authors of memoirs, is sadly denied to practicing politicians"!!

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