Thoughts on Bear Stearns

Bob Reich, whom I knew vaguely long ago, writes a demagogic column for the American Prospect about the Bear Stearns “bailout”:

Some of the dollars I’m sending to Washington are now being used to backstop Wall Street investment bankers, hedge fund and private equity managers, and anybody else associated with a borrower that’s too big to fail.
The reason they’re too big to fail is they’ve borrowed so much from me and from you – from our pension funds and money-market funds – that if they went bust, our savings would disappear. ***
The reason they’ve been able to borrow so much from us without putting up much of their own capital is they’re unregulated, and don’t have to put up their own money.

Actually, Bear Stearns never borrowed anything from me. I’m highly doubtful that they borrowed from Reich, either.

Maybe I’m groggy from doing my taxes all night, but this doesn’t make sense to me. I do want a tax system that rewards risk taking. But not any risks – and not one where it’s heads they win and tails I lose.

Let’s review some basic facts: this chart shows Bear Stearns’s stock price over the last year:

That’s right: Bear Stearns lost more than 80% of its value virtually overnight. Some “bailout.” Reich says “heads they win and tails I lose.” But Bear Stearns obviously lost, and Reich didn’t, unless he was a Bear Stearns shareholder. Ben Bernanke testified today that he didn’t expect any net cost to taxpayers on the “bailout.”
I don’t pretend to have mastered the intricacies of the Bear Stearns collapse; I’m not sure anyone has. But these comments by SEC Chairman Chris Cox at a Senate hearing this morning were interesting:

Our oversight of the CSEs includes monitoring for firm-wide financial and other risks that might threaten the regulated entities within the CSEs, especially the U.S. regulated broker-dealers and their customers.
In particular, the SEC requires that firms maintain an overall Basel capital ratio at the consolidated holding company level of not less than the Federal Reserve’s 10 percent well-capitalized standard for bank holding companies.
At all times during the week of March 10th through 17th, up to and including the time of its agreement to be acquired by JPMorgan, Bear Stearns had a capital cushion well above what is required to meet the Basel standards.
Specifically, even at the time of its sale, Bear Stearns’ consolidated capital and its broker-dealers net capital exceeded relevant supervisory standards.
Even prior to the experience with Bear Stearns, the SEC’s supervision of investment bank holding companies has always recognized that capital is not synonymous with liquidity. A firm can be highly capitalized while also having liquidity problems.
So in addition to a healthy capital cushion, the firm needs sufficient liquid assets in the form of cash and high-quality instruments such as U.S. Treasury securities that can be used as collateral for loans in times of stress.
For this reason, the CSE requirements are designed to ensure that an investment bank holding company can meet all of its cash needs even in the face of a complete cutoff of unsecured financing that lasts for a full year.
In these ways, the CSE supervisory model has focused on the importance of both capital and liquidity.
But what neither the CSE regulatory approach nor any existing regulatory model has taken into account is the possibility that secured funding, even if it’s backed by high-quality collateral such as U.S. treasury and agency securities, could become unavailable.
The existing models for both commercial and investment banks are premised on the expectancy that secured financing would be available in any market environment, albeit perhaps on less favorable terms than normal.
For this reason, the inability of Bear Stearns to borrow against even high-quality collateral on March 13th and 14th was an unprecedented occurrence. And that is what’s prompted the Fed’s action to open the discount window to investment banks.

Some people talk about economic matters in good faith, others demagogue them. It’s generally not hard to tell which is which.
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