The Bear Stearns Implosion: The Beginning or the End?

Financial Solutions Symposium Preview: Dwight Johnston market commentary.


The implosion of Bear Stearns was complete over the weekend with astonishing speed and the direct intervention of the Fed.  Apparently the situation at Bear was much more dire than anyone thought even last Friday.  The $2 per share token fee paid by JPMorgan for Bear, with the Fed providing all the funding for the $30 billion in assets acquired from Bear, was astounding.  This was clearly just a ruse to avoid the lengthy and potentially more disrupting bankruptcy process.  By the way, apparently the Fed is also taking the risk on those $30 billion in assets.  This means that you might end up helping to pay for Bear Stearns mistakes.

The Fed didn’t stop there though.  They cut the discount rate to 3.25% and, more importantly, the Fed opened the discount window directly to primary dealers.  They will accept any high quality collateral.  The Fed is also extending repo agreements from 30 to 90 days.  The Fed is clearly in panic mode and is pulling out all the stops to ease the liquidity crisis.  The FOMC meets tomorrow, and now the markets are expecting a rate cut of 100 basis points.  Some analyst believes the Fed might even cut rates this morning if stocks get beat down today.  Others believe the Fed’s liquidity moves means the Fed will de-emphasize the rate cut.

Previous financial crises have ended with the failure of one big financial name.  Maybe Bear Stearns will be this year’s Long Term Capital Management or the 1980’s Continental Bank.  But fear is running rampant now.  Lehman and UBS are being bandied about as the next failures.  But maybe the carnage will stop here. 

What is the most bizarre thing to realize in all of this is that the actual losses on the underlying collateral of the securities are still very minimal.  This carnage is all due to the insanity of mark-to-market!  Banks and brokers have to divine some mark-to-market value on securities that aren’t trading.  So, every time some distress happens in the market, the “theoretical” value of securities drops further. This is a vicious circle, and no amount of liquidity ploys by the Fed will stop it until the government guarantees virtually the entire banking and brokerage system. 

One thing that should have happened early on is that the government should eliminate the mark-to-market valuation requirement; get rid of this accounting rule until there is actually a market.  Forget another rate cut. 

Dwight Johnston will be a keynote speaker at the Financial Solutions Symposium. He will talk about the Fed actions and their impact on credit unions.




March 17, 2008


  • Most people don''t have your keen insight into the "theoretical" nature of mark to market accounting and valuations, so I hope you appreciate their reluctance to deal with institutions that, by all appearances, are worthless on paper. Hmm, does this sound like anyone we know?
  • I would disagree that the carnage is due to the insanity of mark-to-market accounting. This would not have happened if the banks and dealers had not gorged on copious amounts of structured, excuse me, crap and abandoned disciplined risk assessment practices in the process. Furthermore, how would the government abandoning MTM help when the government is not the lender for most transactions, it''s another bank /dealer that has a legitimate interest in the value of the collateral?
  • Brutal assessment, but right on target. The CU industry needs as much candor as it can get.
    Marvin C. Umholtz
  • Right on Dwight. The regulators insistance that we view our organizations at the liquiditation value instead of a going concern makes us vulnerable to whipsaws in market situations regardless of our intent to continue. This is the same reasoning that lead to the liquidation of CapCorp when WesCorp was more than willing to take on the investments and hold on till maturity or a better market. “Ride out the storm” is not in our Government‘s box of tools.
    Gregg Stockdale