The Bear Stearns meltdown story has been such a rapidly moving target that much of what gets written about it has a shelf life of hours at best. Wall Street insiders had barely finished their high-fives at the self-immolation of their nemesis, New York Governor Elliot Spitzer, when rumors began to circulate that a major investment firm was facing a capital crisis. Bear was quickly identified, and the crisis turned into a good old fashioned run on the bank.
J. P. Morgan Chase stepped up in a move reminiscent of that of John Pierpont Morgan, who led a group of fellow bankers to quell the panic of 1907. In the 2008 remake, J. P. Morgan Chase, backed by a guarantee from the Federal Reserve, loaned Bear the money it needed to honor its commitments.
No sooner had the critics attacked the Fed for putting taxpayer money at risk to “bail-out” Wall Street, noting that Bear Stearns had been especially enamored of the high risk, take no prisoners, swashbuckling form of investment banking and was a leading backer of those who made sub-prime mortgage loans, when the other shoe dropped -- the announcement that J.P. Morgan Chase was buying Bear at the fire sale price of $2 a share.
Bear was trading at $67 a share just two weeks earlier, so it was no longer possible to claim that Bears’ owners were being bailed-out. Even after the deal terms were revised, bringing the price to $10, the loss for Bear shareholders, and the company executives and other employees holding 1/3 of the shares, remained devastating for most. It does seem like the punishment fits the crime.
There is ample precedent for the government to play a major role in averting a financial crisis. $30 million of federal money was pledged during the bank runs of 1907. In 1933, the Home Owner Loan Corporation (“HOLC”) was created to help mortgage holders. In 1984, the Fed stepped in when Continental Illinois became insolvent. And you might recall the huge savings and loan crisis in the 1980s.
Each time the government orchestrated one of these “recues” new regulations and more bureaucracy came along for the ride. Until, of course, we forgot the crisis we had survived and let our guard down. “Greed,” as Gordon Gecko famously said in the movie, Wall Street, “is good”. At least, Wall Street thinks it is good and already Wall Street insiders are pounding their fists on the tables, complaining about proposals to increase the regulation of investment banks, hedge funds and others seen to have precipitated the housing bubble. The strange thing is just a week earlier these same people were pounding their fists on the table, demanding that the government do something to save them from disaster.
I recently interviewed Jack Bogle, founder of The Vanguard Group and an outspoken critic of much that goes on in the financial services industry. Bogle has never been one to pull his punches and said, “It is to me remarkable that all these capitalists who say just keep the government out of the way and we'll do fine are the first ones in line when they're coming to search for help -- you know, go to the government whenever you get in trouble.”
Bogle actually wants to see the return of the Glass-Steagall Act which, among other things, separated commercial banking from investment banking. I don’t think Congress will go that far. But now that the Fed has opened its discount window to investment banks, which means it will put taxpayer money at risk to provide investment banks with capital when needed, Congress is certain to require additional oversight. There is no such thing as a free lunch and commercial banks, the “depository institutions” for which the discount window was designed, pay a price for the privilege by way of risk-based capital guidelines. They also are subject to various reporting requirements. At the least, the investment banks are going to have to become much more transparent in their operations.
Beyond that, policymakers must now balance between restraints designed to protect the financial system and restrictions which will stifle innovation in a rapidly changing world-wide economy. It will not be an easy task, and the outcome may well turn on the result of the upcoming national election.
Clearly the financial engineering that bundled mortgage-backed bonds into pools of securities (Collateralized Debt Obligations) which hid their true risk characteristics needs to be reined in. That’s just Wall Street being too clever for anybody’s good.
But at the same time, Main Street is not completely innocent in this business. It might make sense for the government to do more direct lending, like the Depression era HOLC. But a no money down, no document mortgage just doesn’t make sense at any level, not for the lender and not even for the would-be homeowner who can’t qualify any one way. If it sounds too good to be true, it probably is too good to be true and should be avoided.
I only wish I could borrow at the discount window. I’d save a heck of a lot on my mortgage interest. And my credit is better than Bear Stearns.
