1929

It's going to be a rough day. Probably a rough week.

The weekend action by the government to allow JP Morgan to buy Bear Stearns at a fire sale is akin to putting chewing gum on a dam breach. It keeps the market liquid, but the system is far from secure.

The action, according to the Wall Street Journal was motivated "by a concern that a rapid and disorderly failure of Bear Stearns would wreak havoc on the markets in which the firm is an intermediary, particularly the huge and important securities-repurchase, or 'repo' market."

Bear Stearns risked defaulting on extensive 'repo' loans, on which firms pledge securities as collateral for overnight loans from money-market funds. If that happened, other securities dealers would find their access to repo loans restricted. The pledged securities behind those loans could be dumped in a fire sale, deepening the plunge in securities prices.

As a result, one of regulators' priorities in any deal for Bear Stearns or its parts is to minimize the risk to the financial system. That suggests that they want those counterparties furthest removed from Bear Stearns itself to know immediately where they stand in any deal, and for a buyer to have sufficient financial strength to reassure those counterparties.

But this isn't where the problem ends. Bear Stearns was a public company and the fire sale price of $2 per share left lots of people with next to worthless stocks. Since 77 percent of Bear Stearns stock is held by institutions and mutual funds, that means companies and individuals' private investments took at beating.

How much? Friday morning, after a week-long run on Bear stock, shares dropped from $54.79 to $26.85. When the market opened this morning, the stock began at $2. Within the past year, Bear Stearns stock traded for as much as $159.36. That means if you were unlucky enough to buy 100 shares at the peak, your investment of $15,936 is now worth $200. Or at least it was at the open.

That's pretty daunting, but now consider who the major stockholders in Bear Stearns are: Morgan Stanley, Legg Mason, Barclays, Vanguard, Janus -- major bankers all. They, too, are part of the financial system and they just lost a bundle.

Morgan Stanley is the largest recognizable name and it held 6,335,729 shares, or a little more than five percent of Bear Stearns. Friday morning that was worth more than $347 million. That stock is now worth a little more than $12.5 million.

Among mutual funds, Vanguard's Windsor fund held more than seven percent of Bear with 8,358,352 shares. It was the 24th largest holding in the fund. While that may be a small percent for the fund as a whole, investors who had significant holdings in that fund will likely take a beating.

All this -- and what's left to come -- because of the administration's failure to provide proper oversight to the lending community. By allowing a system to exist that encouraged retail lenders to make loans to people who could not handle the risk, then sell those loans to people who likely didn't know the extent of the risk involved.

It is a classic pyramid scheme that works for everyone as long as the cash is flowing, but once a break occurs, it all topples down. In this case, when interest rates went up, those unqualified borrowers could not make their payments. Loans went into default and the banks suddenly didn't have the cash or assets to support their businesses. On the other end, houses flooded onto the market, boosting inventory, depressing prices and setting the stage for what will be a dreadful summer for home building. People who borrowed money against all the equity in their homes, will soon find that the value of their homes won't support those loans.

It's greed gone wild and you can bet the Republican administration will make sure its friends are protected. It's those of us at the bottom end of the food chain that will suffer the most in this catastrophe.

    -- Jim Grinstead

Comments

[Blue Collar Muse]

Jim -

I agree that it's greed gone wild. But the greed wasn't confined to Wall Street.

What about the greed of individuals that took out loans they could not afford or who gambled that they'd be able to make larger payments later and so bought at a low payment then?

This isn't just a Wall Street problem. Some of your neighbors are to blame for this, too. If you're going to throw stones and assign blame, be sure you include everyone.

The only good thing to come from this is that perhaps we'll have enough people mad at both Mommy Welfare and Daddy Welfare that we'll be able to reduce or eliminate both.

Blue

[Jim Grinstead]

Is it greedy to want a home for your family? It's perhaps bad judgement to sign on to a loan that is too risky for your financial position, but it's a leap to call that greedy.

Many, if not most of the people who fell into this trap were entering the housing market for the first time. They didn't have the experience to fully know the risks involved.

That doesn't mean they shouldn't bear some of the responsibility, but while education is part of the solution, government regulation to protect not only borrowers, but investors from potential distaster is a better solution.

Thanks for the comment.

Jim