Bear Sterns ( Bail Out )

Barrons Articale

THERE NO LONGER CAN BE ANY doubt that the Federal Reserve's overwhelming priority now is to perform the function for which it was created -- to act as lender of last resort to the financial system.
Friday's announcement of an emergency funding package for Bear Stearns from the New York Fed via J.P. Morgan Chase was but the latest in the series of steps the central bank has taken in just the last week to shore up liquidity, the lifeblood of all financial institutions.
Technically, Bear will get credit from J.P. Morgan Chase, which will obtain a "non-recourse loan" from the Fed's discount window. This back-door maneuver is being used because, explains Joan McCullough, an analyst with East Shore Partners, an independent research boutique, only depository institutions normally may borrow directly from the Fed, not investment banks such as Bear.
The latter would need to get so-called Emergency Funding, which would require approval of the Federal Reserve Board, and would send a bad signal to the markets, she adds.
Moreover, the risk for the loan to Bear will be borne by the New York Fed, not J.P. Morgan Chase's shareholders. There is precedence for such a scheme, however. If memory serves, when the commercial paper market seized up after the Penn Central collapse of 1971, the Fed let banks know they could avail themselves of the discount window in order to provide companies with loans to replace maturing commercial paper that couldn't be rolled over.
This cash infusion initially relieved the stress on Bear's credit derivatives, but the cost of insuring against its default reversed and rose sharply Friday.
That speaks to Bear's basic problem. "Bear Stearns needs to raise $3 to $5 billion of EQUITY within the next couple of days to address concerns," Egan-Jones Ratings emphatically writes. "It needs support or firms will withdraw doing business down business" with Bear. As a result, the stock is down sharply on the news of the firm's life-support from the Fed via J.P. Morgan Chase.
As for the Fed's next move, odds rose sharply in the federal-funds futures market of another big cut in the key rate at Tuesday's meeting of the Federal Open Market Committee. A cut of 75 basis points, to 2.25%, is fully priced in while odds of a 100 basis-point cut, to 2%, are about one in three, after having been nil Thursday.
Though the probabilities of a larger rate cut might have been notched up by Friday morning's dramatic events, it pains me to admit that much, if not all, of the thinking of the U.S. central bank's policy-setting panel has been set out in the pages of one of our most estimable competitors.
In Thursday's edition of the Financial Times, the lead story declares: "The U.S. will avoid a serious slump similar to the Japanese recession in 1990s because U.S. policy makers will do whatever it takes to avert such an outcome, the Federal Reserve believes."
Let us agree at the outset that nothing happens for no reason. Then consider this extraordinary sentence from my perspective, one with 35 years in financial journalism as a reporter and an editor.
This is an extraordinary assertion, that America will avoid a prolonged recession comparable to what Japan experienced in the last decade, and indeed continues to be mired in. Moreover, U.S. policy makers will take any and all steps to prevent that outcome.
Firstly, the FT declares that U.S. economic policy makers have decided what is the clear and present danger facing the American economy—a debt deflation similar to what beset Japan in the previous decade. (Debt deflation occurs when liquidation of declining assets to meet debt obligations creates a vicious circle of price declines.)
That is remarkable because as readers take this in, the dollar continued its slide, to below 100 yen to the dollar; oil continued to soar, to over $110 for a barrel of crude; and gold commanded $1,000 an ounce, if only for a short time.
There is a clear fork in the road for the economy—between rising prices of tradable goods and a falling value of the dollar, and the asset-price deflation being felt in American homes. And as Yogi Berra advised, when you reach that fork in the road, take it. And the Fed has opted for the latter, to focus on the falling prices of Americans' major asset, the Britsh paper claims.
Even more remarkable is that the FT offers no substantiation about the source of the knowledge about the Fed's purported belief.
There are no references to "sources close to the Fed" or "people familiar with the Fed's thinking." Indeed, the story was, to use the current argot of turning noun into a verb, poorly sourced.
So much so, in fact, that I do not doubt its veracity for a moment.
As an editor, I would never let a story run were I not fully confident in the reporter's sources on the story. As a reporter, I can't imagine getting my story past an editor without convincing her or him that it was solid in its sources, even if they weren't named.
Finally, as an editor, I can't imagine running a story that purports to reveal the Fed's thinking, without citing a source, as the leader on page one were I not fully confident about its veracity in its facts, and also in its interpretation of those facts?.
Indeed, from the standpoint of an editor and a reporter, I can only infer the facts of the FT story were indeed correct or else it would not have run in the form it did, lacking the most rudimentary citation of sources for its assertion. After all, the story did not run under the byline of Jayson Blair; neither was it in a newspaper known for playing fast and loose with the facts.
I cannot deny my credulity because the FT's take on the Fed's thinking jibes with mine. I see the world in much the same terms as Ben Bernanke—that the collapse of Americans' largest asset poses the single biggest threat to the financial system and the economy.
As for "whatever it takes" to counter the impact of a debt deflation, the current Fed chairman continues to take away from the example of his illustrious predecessors, notably Paul Volcker, the Fed chairman from 1979 to 1987.
During that span, not only was the back of inflation broken but the impacts of two major banking crises were dealt with, the Latin American loan crisis that hit its crescendo in the early 1980s and the Continental Illinois collapse in 1984. In the latter case, the Fed funneled needed liquidity into the wobbly Chicago bank from the rest of the system.
The Bernanke Fed is attempting to do something similar now. Its Term Auction Facility, which effectively provides reserves for banks that need them most, has been relatively successful.
In the past week, the central bank acted to increase liquidity, first to the banking system by expanding its TAF, providing reserves where they're most needed. And it lent securities, in this case, mainly Treasuries, while taking in mortgage-related securities, in an attempt to loosen the financial system away from banks.
Since the FT story was published, any question whether the economy should be settled with news of a surprise drop in retail sales in February, which should come as no surprise following the second straight decline in non-farm payrolls last month. And the inflation bogeyman should be put to rest with the unchanged reading on consumer prices, with or without food and energy prices, in February.
What's next? Somehow, the Fed will try to funnel liquidity where it's needed most. That's its key priority currently, notwithstanding the dollar, gold or oil.
The key conclusion to be taken away is that the Fed sees its No. 1 problem as debt deflation and will pull out all the stops to counter it. Whether you agree or not, that's apparently the way it is. And the Bear Stearns bailout bears this out

By RANDALL W. FORSYTH