Monday, March 17, 2008

Update on Can the Fed engineer a turnaround

Update on this post where I suggested:
Assuming that the same institutions who invested in these securities can classify them as toxic or possibly non-radioactive then a workout perhaps similar to the Resolution Trust for S&L can be created for the toxic securities ...

Today, Paul Krugman echoes something similar in the NYT:
Looking ahead, we probably need something similar to the Resolution Trust Corporation, which took over bankrupt savings and loan institutions and sold off their assets to reimburse taxpayers.

Today the news is all about the Fed "bailout" of Bear Stearns - the Fed has agreed to help finance the buyout of of Bear Stearns at $2 per share by JP Morgan by holding some BS MBS as collateral. Some details at MR and EV.

Update (3/19): JDH expains why this is not a bailout. I would tend to agree although:
"True, the Fed did offer a $30 billion non-recourse loan to JPMorgan to sweeten the deal. But what twist of logic would lead us to describe that as a "bailout" of Bear as opposed to an inducement to JPMorgan to help clean up the mess?" My response: How non-recourse is the non-recourse loan?

Why did the Fed force a fire sale of BS at $2 a share? Is it perhaps sending a signal to other banks/hedge funds/SIVs/SPVs to clean up their act or the Fed will do it for them on the Fed's terms? MR writes:
"The Fed's regulatory powers make crisis deals less than fair. If you, as a bank, don't accept the Fed's terms, you can be prosecuted or thrown in jail or at least ruined by your friendly regulator. Being an advocate of the rule of law, I'm not entirely comfortable with this arrangement, but it does mean that the Fed has a much easier time managing crises. Keep in mind also that the failing banks are indeed the most likely ones to have been criminal, so the unfairness is not usually being applied to the innocent."
MR continues:
"First, the very active role of the Fed in the Bear Stearns crisis must, in the long run, give rise to a fundamental revaluation of the role and powers of the SEC, the entity technically responsible for investment banks. The SEC now appears relatively toothless.
Second, the more commitments made by the Fed, the more we lose the (quasi) independence of our central bank; for a large commitment Treasury sign-off is needed. The realignment of the regulatory universe will eventually emerge as a big story from the current crisis, though it is hardly commanding much attention right now."

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