Roubini on the Bear Stearns Bailout
March 20th, 2008 by Chris KinnanNYU Professor Nouriel Roubini is an outspoken pessimist on the health of the financial system, and I don’t agree with all of his policy ideas. No matter, he nails it with this explanation of the Federal Reserve/JP Morgan Chase/ Bear Stearns deal last weekend:
Claiming the Bear Stearns was not bailed out because the current shareholders got only $2 per share is disingenuous: this was a massive bailout as the Fed put $30 billion of cheap credits in the pot: without this massive financial support not only the shareholders would have been wiped out 100% as they deserved to (rather than keeping the option value that the government support will recover in due time the value of their shares); but also many of the creditors of Bear Stearns would have experienced massive losses as Bear was insolvent and unable to pay such creditors with its impaired assets. Instead the $30 bn Fed support represents a major subsidy for JPMorgan and a major bailout of Bear’s creditors. Effectively the Fed has taken on its balance sheet the entire credit risk of $30 of toxic securities held by Bear Stearns. So, this Fed bail out is an explicit case of using the disastrous Japanese model of a “convoy system” (healthier banks taking over zombie banks with the help of lots of public money) that led to a decade of economic and financial stagnation.
America crossed a line last Sunday, and the costs and scope of the damage (to taxpayers and to the financial system in the form of moral hazard) may not be fully understood for some time.
March 20th, 2008 at 8:55 am
It seems that Bernanke is under the mentality that these short-term solutions will solve all of our problems. However, it seems that they will just create more market volatility and give investors a great sense of uncertainty.
This is great if you are a day trader, but if you are a typical long term investor it seems that Bernanke is only going to make the market more nerve wrecking by not addressing the more major problems.
What would have happened had Bear Stearns continued down the path they were going on without intervention? They would have gone into bankruptcy. So what. Let the market handle itself.
At least if Bear Stearns did go bankrupt, maybe these other banks would take a moment to reevaluate their lending procedures and implement a standard where they only give money to those who they are confident will be able to pay them back. If I were a shareholder of any major lending institution, this would seem like a commonsense demand of the Board I help elect.
While a Bear Stearns bankruptcy would have definitely sent some waves through the markets, at least in the end there would have been a lesson, other than confirming that short-term interventions usually don’t work.
March 20th, 2008 at 11:54 am
Awesome post, Chris. There’s a liberal blogger named atrios who has been out-in-front on this, not so much on the idea side but he was warning years ago about the lending standards that led to the current crisis. He wrote today:
March 20th, 2008 at 12:11 pm
Agreed. The lending industry is in a bit of a catch 22– if they have rigorous lending standards they are “redlining” and if they loosen standards its “predatory.” Clearly both borrower and lender abused the system, in no small part because of the government’s role in subsidizing risk through the GSE’s and the tax code. The LTCM bailout also created moral hazard and helped expand hedge fund recklessness. The ratings industry (Moody’s etc) also clearly dropped the ball and needs more competition as well. Still, the best way forward is to let the market reprice things, in both housing and debt markets. Postponing the day of reckoning with more easy credit– as the fed is now doing– will only make it worse, since this is a solvency problem and not a liquidity problem.