The Quarter Comes to a Close, Thank Goodness

The first quarter of 2008 will most certainly go down in history as one of most turbulent ones in modern financial history. Think about what has happened? ( in no particular order) The credit markets seized up leading to the collapse of the fifth largest investment bank, Bear Stearns. Banks and other financial institutions reported unprecedented losses. The stock markets around the world got rocked. The Federal Reserve went to uncharted territory through massive rate cuts, opening their window to investment dealers, and supported a bank purchase of an investment bank. Large private equity deals have and are going bust. Investors in ‘safe’ securities called auction rate securities lost access to their funds. Housing values continue to tumble. Thousands upon thousands of people across the country are and will face foreclosures on their primary residences. The US economy is most certainly in a recession while the dollar continues to lose value against other currencies and inflation and unemployment are on the rise. Sadly I could go on and on. No wonder people are not happy?

So what lies ahead? Most are just hoping that the worst is behind us but sadly, I do not think it is. The problems are big and it will take a while for it all to work out. In the mean time it makes sense to play it safe financially, investment wise and spending wise. That does not preclude looking for opportunities for long term investments, but it does mean that one should be sure to maintain enough liquidity to ride through the storm. And a storm there will continue to be.

I would like to offer a few words about the announcement today regarding a BLUEPRINT for overhauling the financial regulatory system. The timing of this announcement seems a little crazy to me. The government is clearly trying to send a message of ‘being in control’ but releasing a 200 page document which throws in to question the roles of all the regulatory groups that need to be focusing on the current crisis seems irresponsible. Knowing a little bit about human psychology I would suggest that threatening to change, if not take away, peoples jobs at the same time as you are requiring them to work harder then ever is not a smart thing to do. Hank Paulson said moments ago on CNN that it is his and the authorities number one priority to help manage through this financial turmoil and housing market downturn, and to me, they should be staying focused on that goal. Do we need massive restructuring of the regulatory system to create better alignment with the realities of today’s complex financial system, of course, but now is not the moment to throw the blueprint for that out there.

Is the Bear Stearns Deal “Fair?”

Case studies will be written on went wrong at Bear Stearns. There will be other studies about just what led to an unprecedented move by the Fed to broker the sale of the firm to JP Morgan on March 16th. Reams will be written about how a few days later that bid increased five fold to $10 per share. Though this deal looks likely to stick, the question of whether it is fair remains.

To whom should this deal be fair? Is there such a thing as a collective fair? And is that even the right question to ask? For the 14,000 employees who owned one third of the company, it would seem that $2 was the wrong price, and $10 is a better one, but with time what could that price have been? The authorities determined that their company was toast (unemployment), which is the only course of reasoning that could have led to the any-price-is-a-good price price. But when only one buyer is brought to the table, it seems virtually impossible for anyone to suggest that the price was fair.

To be sure, the buyer was given a weekend to do the impossible: determine a value of a complex financial institution at the center of the network of complex derivative transactions worth trillions. That process alone was likely not fair to the employees of Bear Stearns, but in those famous words spoken by Margaret Thatcher, “Life is not fair.”

As for the surviving banks and investment dealers, was $2 or $10 per share fair to them? If you were to apply the valuation metrics imposed on Bear to any of the many financial firms still standing and forced them to accept whatever price that implied, how would they have reacted? The same way Bear’s employees and shareholders reacted: they would be outraged! Luckily, by selling Bear off quickly, this outcome is unlikely, and you can be sure the survivors are breathing big collective sighs of relief.

What about JP Morgan, was it fair for them? My trader handbook tells me that if you know you are the only bidder, bid low. Period. There is simply no way Jamie Dimon would have done the deal had he not thought he was buying Bear cheap, and that, after all, is his job. He reports to the shareholders of the bank, and not the general public. His job was to secure the best deal possible for his company, and at $2 per share, even $10 per share, he has likely done that. Of course that does not mean that success is guaranteed, but a good trader assesses the risks and prices accordingly.

What about to the FED who backed the deal, was it fair to them? Are we kidding? They may well have pulled off the trade of the century. If the alternative, Bear going immediately down the drain, was the sure consequence, then a $30 billion guarantee was a steal. A few billion here or there is nothing compared to the economic consequences of a financial market meltdown. It is truly impossible to measure the cost of a failure of a financial institution the size of Bear Stearns and that is what continues to be cause for concern. The FED’s job is to protect the integrity of the overall financial markets, and that they did.

And what about the public? Please refer again to the paragraph above. If the financial markets collapsed, billions if not trillions of wealth would have evaporated in a heart beat. The US and arguably the world would have been thrown in to a recession. So yes, if the outcome was in fact the bank’s failure, this is a good outcome for the public.

These are difficult times. The Fed and other government authorities are clearly doing the best they can to ensure that financial markets stay fully functioning but this is not without consequence. Tough and thoughtful decisions are going to be needed when deciding who to save, and who not to. Save too many and you destroy the integrity of the financial markets, save too few, and we could yet experience a market meltdown. As we learned in the movie Bruce Almighty, you simply cannot answer everyone’s prayers even if you are God. What helps some often hurts others. Not only is life not simple, but often it is just “not fair”.

Is the Bear Stearns Deal "Fair?"

Case studies will be written on went wrong at Bear Stearns. There will be other studies about just what led to an unprecedented move by the Fed to broker the sale of the firm to JP Morgan on March 16th. Reams will be written about how a few days later that bid increased five fold to $10 per share. Though this deal looks likely to stick, the question of whether it is fair remains.

To whom should this deal be fair? Is there such a thing as a collective fair? And is that even the right question to ask? For the 14,000 employees who owned one third of the company, it would seem that $2 was the wrong price, and $10 is a better one, but with time what could that price have been? The authorities determined that their company was toast (unemployment), which is the only course of reasoning that could have led to the any-price-is-a-good price price. But when only one buyer is brought to the table, it seems virtually impossible for anyone to suggest that the price was fair.

To be sure, the buyer was given a weekend to do the impossible: determine a value of a complex financial institution at the center of the network of complex derivative transactions worth trillions. That process alone was likely not fair to the employees of Bear Stearns, but in those famous words spoken by Margaret Thatcher, “Life is not fair.”

As for the surviving banks and investment dealers, was $2 or $10 per share fair to them? If you were to apply the valuation metrics imposed on Bear to any of the many financial firms still standing and forced them to accept whatever price that implied, how would they have reacted? The same way Bear’s employees and shareholders reacted: they would be outraged! Luckily, by selling Bear off quickly, this outcome is unlikely, and you can be sure the survivors are breathing big collective sighs of relief.

What about JP Morgan, was it fair for them? My trader handbook tells me that if you know you are the only bidder, bid low. Period. There is simply no way Jamie Dimon would have done the deal had he not thought he was buying Bear cheap, and that, after all, is his job. He reports to the shareholders of the bank, and not the general public. His job was to secure the best deal possible for his company, and at $2 per share, even $10 per share, he has likely done that. Of course that does not mean that success is guaranteed, but a good trader assesses the risks and prices accordingly.

What about to the FED who backed the deal, was it fair to them? Are we kidding? They may well have pulled off the trade of the century. If the alternative, Bear going immediately down the drain, was the sure consequence, then a $30 billion guarantee was a steal. A few billion here or there is nothing compared to the economic consequences of a financial market meltdown. It is truly impossible to measure the cost of a failure of a financial institution the size of Bear Stearns and that is what continues to be cause for concern. The FED’s job is to protect the integrity of the overall financial markets, and that they did.

And what about the public? Please refer again to the paragraph above. If the financial markets collapsed, billions if not trillions of wealth would have evaporated in a heart beat. The US and arguably the world would have been thrown in to a recession. So yes, if the outcome was in fact the bank’s failure, this is a good outcome for the public.

These are difficult times. The Fed and other government authorities are clearly doing the best they can to ensure that financial markets stay fully functioning but this is not without consequence. Tough and thoughtful decisions are going to be needed when deciding who to save, and who not to. Save too many and you destroy the integrity of the financial markets, save too few, and we could yet experience a market meltdown. As we learned in the movie Bruce Almighty, you simply cannot answer everyone’s prayers even if you are God. What helps some often hurts others. Not only is life not simple, but often it is just “not fair”.