Anatomy of a coup: Part 2, Friday and Saturday
[Continued from yesterday’s Part 1.]
I think the invention of global securitization is at best an act of naivete, and at worst an unsupportable negligence. We’ve stayed financially solvent because we’ve built up an equity, and we’ve kept the liquidity and credit markets because we’ve dealt with counterparties who knew we would take that equity. And now we’re asked to believe that a piece of rating agency paper will take the place of underwriting and site visits, and that a financial community that hasn’t taken on any risk it could shed in the history of its existence will now, for our convenience, do precisely that. I have strong doubts, gentlemen.
– Seven Days in May, General James Mattoon Scott, translated from milspeak into finspeak
Yesterday’s post, one of several detailing the financial coup of the 21st century, covered the hectic days Saint Patrick’s Day weekend. As reported in the Congressional testimony offered by Timothy F. Geithner, CEO of the Federal Reserve Bank of New York, when the sun set on Thursday, March 13, 2008, it appeared Bear Stearns would have to file bankruptcy the next morning, with incalculable consequences for the intertwined global capital markets.
Friday, March 14, 2008
To their credit, the Fed bankers pulled an all-nighter:
Probably without the beer
Following that initial call with the SEC on March 13, my colleagues in
So did the condemned men of Bear:
Bear renewed conversations that began earlier that day with JPMorgan Chase, which is Bear’s clearing bank for its repo arrangements, to explore a range of possible financing options.
As I previously posted in One foot in the Bear trap?, JPMorgan found itself in the middle of these negotiations more or less because it had to be. It had more to lose from Bear’s collapse than any other bank on Wall Street. Conversely, it had more to gain.
The New York Fed dispatched a team of examiners to Bear Stearns to look at its books so that we could get a better handle on what could be done. We gathered the best information we could, evaluated the risks involved, and explored a range of possible actions.
After Thursday the 13th, it seemed that Bear wouldn’t live out the day
At 5:00 a.m., we participated in a conference call with our colleagues at the Board of Governors and the Treasury to review the options and decide on the way forward. After careful deliberation, together we decided on a course of action that would at least buy some time to explore options to mitigate the foreseeable damage to the financial system.
Time costs money: in this case, as events will show, it cost Bear $4,000,000 for one day – which, as we’ll see, was cheap at the price.
I deliver value
With the support of the Secretary of the Treasury, Chairman Bernanke and the Board of Governors agreed that the New York Fed would extend an overnight non-recourse loan through the discount window to JPMorgan Chase, so that JPMorgan Chase could then “on-lend” that money to Bear Stearns.
“Ben, I sure pray you’re right about this.”
This action was designed to allow us to get to the weekend, and to enable us to pursue work along two tracks:
First, for Bear to continue to explore options with other financial institutions that might enable it to avoid bankruptcy; and
Second, for policymakers to continue the work begun on Thursday night to try to contain the risk to financial markets in the event no private-sector solution proved possible.
Those actions, everyone realized, were scarcely more than the ante in a game of no-limit poker:
Over the course of that day, March 14, Bear was downgraded by the credit rating agencies, and the flight of customer business from Bear accelerated.
Meltdown.
Overloaded by sell orders
Had the weekend not intervened, would the Fed have extended Bear’s loan for another few days? We’ll never know.
This set in motion a chain of decisions across the financial system as market participants prepared for the possibility that Bear would not be open for business once Asian markets opened on Sunday night.
Everybody waiting for the signal to start running away
This highlighted the urgency of working toward a solution over the weekend, ideally a solution that would definitively address the prospect of default by Bear.
Saturday, March 15, 2008
At this point, three entities were principally connected, each searching for a solution that would help the other two:
Bear, one foot already in the grave.
JP Morgan, shackled to Bear by its guarantees.
The Fed, shacked to everybody by fear of market seizure.
Everybody keep running in step, okay?
Bear approached several major financial institutions, beginning on March 13. Those discussions intensified on Friday and Saturday. Bear’s management provided us with periodic progress reports about a possible merger.
In a crisis, uniforms are a less than perfect guide to character.
“Character is what you are in the dark!”
Instead, you find out who can see the bigger picture, who wants to act rather than pause, who’s willing to take the risks. One of the clues is who communicates with internal transparency. Crisis situations require all the information, all the time — don’t hold anything back.
Although several different institutions expressed interest in acquiring all or part of Bear, it was clear that the size of Bear, the apparent risk in its balance sheet, and the limited amount of time available for a possible acquirer to conduct due diligence compounded the difficulty. Ultimately, only JPMorgan Chase was willing to consider an offer of a binding commitment to acquire the firm and to stand behind Bear’s substantial short-term obligations.
I’ve previously speculated that JPMorgan was both intrigued and ‘pot-committed’ (in the poker sense) – with what they had already invested, even if the odds of success were dropping, it was still worth covering the remaining bets to have a chance at the pot.
As JPMorgan Chase and other institutions conducted due diligence, my colleagues in
Even though you have allies in a crisis, you must always look at the unilateral alternatives, and what you do if the other parties don’t make it.
Just checking my options
But your commitment should be to find a solution:
We did, however, have the ability to lend against collateral, as in the back-to-back non-recourse arrangement that carried Bear into the weekend. After extensive discussion with my colleagues at the New York Fed, Chairman Bernanke, and Secretary Paulson, and with their full support, the New York Fed and JPMorgan Chase reached an agreement in principle that the New York Fed would assist with non-recourse financing. Using Section 13(3) of the Federal Reserve Act, the
It takes a real friend to lend you $30 billion to buy assets from a possibly sinking bank.
Did you get all your assets, darling?
It takes a courageous friend to promise this in principle before obtaining binding approval.
You don’t have to be old to chart the stormy seas
It takes a wise friend to be right.
This step made it possible for JPMorgan to agree to acquire Bear and to step in immediately to guarantee all of Bear’s short-term obligations. This guarantee was especially important to stave off the feared systemic effects that would be triggered by the panic of a Bear bankruptcy filing and of the failure to honor its obligations. And by agreeing to lend against a portfolio of securities, we reduced the risk that those assets would be liquidated quickly, exacerbating already fragile conditions in markets.
Here’s the revolutionary coup – the realization that a new form of credit was required, an act of faith that assets had intrinsic value greater than their fire-sale clearance price.
The portfolio of securities is described in Annex II to this testimony.
The move was heroic, and it was locked in place that Saturday night.
Only one take
[Continued tomorrow in Part 3.]
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