The Bear Necessities

I thought that I had accomplished a lot over the weekend, until I read about the stunning Bear Stearns deal. In a remarkable turn of events, Bear agreed to sell itself two days after receiving emergency funds from J.P. Morgan Chase & Co. and the Federal Reserve Bank of NY.

Actually, the sale wasn’t the shocking part, but the price was: after closing down 47% on Friday to $30 per share, the 85-year old investment banking firm will sell itself for $2 per share to JP Morgan. To help grease the wheels of the deal, the Fed approved a $30 billion credit line to JP Morgan and said that it would effectively take over the huge Bear Stearns portfolio.

Separately, the Fed also lowered the rate for borrowing from the discount window by a quarter of a percent to 3.25%, in order to facilitate smoother financial market operations and further expanded last week’s $200 billion liquidity injection by creating the Term Securities Lending Facility (TSLF). The TSLF will make money available to the 20 large investment banks that serve as primary dealers and trade Treasury securities with the Fed. This program will allow the Fed to hold as collateral a wide array of investments, including the now-tarnished mortgage backed securities, and will have no limit on the amount of money that can be borrowed.

While I understand how many believe that those who created this mess should suffer, officials are thankfully pushing aside the worries about “moral hazard” so that financial system does not become crippled altogether. I see the Fed actions as necessary to help halt the forced sell-off of high quality mortgage backed securities. These moves are less financially-motivated than confidence-builders. Clearly the root of the economy’s fundamental problems can not be solved by the Fed. After all, the central bank can not stop housing prices from falling. But what it can do is provide liquidity to financial institutions which might prevent what is known on the street as a “death spiral”, or a bank run.

If you do not own Bear Stearns stock (which you may, because it was part of the S&P 500 Index), how is all of this going to affect you? Well it has created a ripple throughout the entire financial services industry. Shares of investment banks in the S&P 500 are down almost 30% this year, the overall market (as measured by the S&P 500 index) is down over 12% this year and over 17% from its most-recent high last October. But in a larger sense, the events of the past week imply that the Fed will do everything in its power to stave off financial instability and that is actually a good thing.