Can the Fed Bail Out a Non-Bank?

The point about the Fed's power to backstop a deal from a bank to a non-bank is an interesting one we had not thought about, although we did point out Bear's non-bank status in our 'smoking gun' piece when we noted it does not appear on any of the OCC lists of banks with large derivative exposure.

The secondary point about four governors approving without including the fifth governeror Mishkin is only interesting if he were to object.

This will be a first in a series of tests of the boundaries of the Fed's power to intervene in US markets. This is not analagous to the LTCM situation where the Fed merely arranged the deal. In this case the Fed holds all the counterparty risk for JPM, and is really the principal with JPM acting as its agent.

The real test, the real 'crossing of the Rubicon' will be when the Fed exhausts its own asset side of its balance sheet, expressed as the Fed Held portion of the H.41 report. A few more deals like this and they will be there. What they do next, what new linkup they provide, will be where we cross the Rubicon from the existing Federal Reserve system to the netherworld of a purely whimsical form of money beyond even the discipline of the public debt markets.

Housing Group Challenges Fed's Bear Stearns Deal
By REUTERS

Published: March 16, 2008 Filed at 1:07 p.m. ET

WASHINGTON (Reuters) - A housing and fair lending activist group has challenged the legality of the Federal Reserve's quick approval of financing for Bear Stearns via JPMorgan Chase , questioning the Fed's authority to approve the deal because it involves a non-bank institution.

Inner City Press Community on the Move, in a complaint filed with the Fed late Saturday, called the central bank's brokering of the deal "entirely illegal" and anticompetitive, and questioned whether sufficient Fed members had voted for it.

In a first step toward challenging the bailout, Inner City Press questioned the legality of the Fed approving the deal without public notice, on the grounds Bear Stearns "is not a banking holding company and does not own a bank."

The Fed approved financing to Bear Stearns through JPMorgan in an emergency meeting Friday morning.

It was the Fed's first rescue of a broker since the Great Depression and its latest effort to soothe financial markets roiled by fallout from rising mortgage defaults.

But Matthew Lee, executive director of Inner City Press, vowed to take all needed legal actions against the deal.

"The Fed has hit a new low with this, they did nothing to protect consumers from predatory lending and now their response is to bail out one of the most notorious enablers of predatory lending with no benefit to struggling consumers," said Lee.

"This should be taken as far as it can go to finally bring the Federal Reserve to account that they work for the public interest and not only Wall Street, particularly in a time of crisis," he told Reuters on Sunday.

The Fed could not immediately be reached for comment.

Inner City Press, a nonprofit group that has challenged the nation's key bank mergers over the past decade in an effort to ensure poorer communities are served fairly, also questioned why only four of the five Fed governors approved the measure.

The Fed approved the deal between JPMorgan and Bear Stearns under Depression-era laws allowing it to do so under "unusual and exigent circumstances." This provision, however, requires an affirmative vote of not less than 5 members of the board.

At present, there are only five members on the board with two vacancies, but only four approved the measure because governor Frederic Mishkin was not present, according to the Federal Reserve.

But current law mandates that no less than five members can vote on the matter and states that members can be contacted through any electronic means, including by telephone and e-mail.

"There has been no showing that, given technology in 2008 (as opposed to the 1930s when this language was enacted), the required attempts to contact Gov. Mishkin were made," Lee wrote in the complaint.

Inner City Press also questioned whether the deal could be finalized without antitrust review.

"Third, to allow this relation between the nation's third largest bank and fifth largest brokerage, without any antitrust review, even with the required votes (which the Fed) did not have, is unlawful," the complaint stated, requesting public hearings on the matter.

The complaint also asks for a probe into Bear Stearns' disclosure of its financial condition, citing an interview the firm's chief executive gave on CNBC television earlier in the week during which no mention of the scope of the firm's financial troubles were made.

(Reporting By Joanne Morrison; Editing by Tim Dobbyn)

Paulson "Will Do Whatever it Takes"

Indeed, Paulson will do whatever it takes to bail out his friends on Wall Street. The price for this will be paid by all holders of the US dollar.


Paulson Says He'll `Do What It Takes' to Calm Markets
By Brendan Murray

March 16 (Bloomberg) -- Treasury Secretary Henry Paulson said the U.S. will ``do what it takes'' to maintain confidence in financial markets and defended the bailout of Bear Stearns Cos. as ``the right decision.''

``There's always a decision to be made to say what's best for the stability of the marketplace, the orderliness of the marketplace,'' Paulson said in an interview in Washington on the ``Fox News Sunday'' television program. ``I think we made the right decision.''

Paulson, 61, spoke two days after the Federal Reserve was forced to give an emergency loan to Bear Stearns, the fifth- largest U.S. securities firm. The move failed to avert a crisis of confidence among Bear Stearns customers and shareholders, who drove the stock down a record 47 percent.

In separate appearances today, the former chairman of Goldman Sachs Group Inc. called the rescue ``the right decision'' and expressed ``great confidence'' in Fed Chairman Ben S. Bernanke. Paulson said that in the case of Bear Stearns, the risk to financial stability outweighed his concern about so- called moral hazard, in which investors come to expect government rescues.

``I really understand the moral hazard argument,'' he said. ``On the one hand, you've got moral hazard and on the other you've got what's right for the markets, what's right for the stability of the financial system and the U.S. economy.'' (this Republican administration has the moral sensitbilities of a billy goat. - Jesse)

Bear Stearns Talks

Paulson said ``conversations are going on over the weekend'' about Bear Stearns. ``I'm very involved in those conversations.'' He declined to be specific about the future of the 85-year-old firm, the second-biggest underwriter of U.S. mortgage bonds, or say whether any additional government steps are planned.

``The government is prepared to do what it takes to maintain the stability of our financial system,'' Paulson said. ``Our focus, our No. 1 priority, is the stability of our financial system.''

The Treasury chief refused to say what a growing number of economists have concluded -- that the economy has entered a recession.

``Economists are going to be debating that for months and months,'' he said. ``It's much less important what you call it than what you're doing about it.''

The Standard & Poor's 500 Index is down 12.3 percent this year, while the dollar is down 5 percent against a basket of currencies of major U.S. trading partners. Home foreclosures in January and February year were up 58 percent from the first two months of 2007.

Faith in Institutions

``I've got great confidence in our financial markets and our financial institutions,'' Paulson said. ``Our markets are resilient, are flexible. Our institutions -- our banks and investment banks -- are strong.'' (Sounds like the CEO of Bear Stearns the day before his company rolled over - Jesse)

Paulson repeated his support for a ``strong dollar,'' and said the long-term strength of the U.S. economy would be reflected in the country's currency. (Anyone who believes this anymore is a simpleton - Jesse)

President George W. Bush is scheduled to meet tomorrow with his Working Group on Financial Markets. Paulson chairs the group, which includes Bernanke and Securities and Exchange Commission Chairman Christopher Cox.

The Bush administration has resisted the use of government funds or guarantees to stem the surge in foreclosures. Paulson has brokered a series of voluntary accords among lenders to freeze interest rates on subprime loans and negotiated a one- month moratorium on foreclosures.

`Fragile' Markets

A credit crisis that began in August has left markets ``more fragile than we would like right now,'' Paulson said in a separate interview on ABC News's ``This Week'' program. ``My concern is to minimize the impact on the broader economy.''

Paulson said the administration doesn't support measures in Congress to help struggling homeowners.

House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Christopher Dodd offered a plan last week to let the Federal Housing Administration insure refinanced mortgages after lenders reduce principal to help struggling borrowers.

The two lawmakers are leading congressional efforts to tackle the surge in foreclosures, which reached record levels in the fourth quarter of 2007. Their plan goes beyond the Bush administration's approach that relies on voluntary agreements between lenders and loan servicers to modify mortgages for borrowers who can't make their monthly payments.

``I'm looking very carefully at any proposal, but all the ones I've seen call for much more government intervention, raise more problems, do more harm than do good,'' Paulson said in the ABC interview.

Greater Oversight

Paulson last week proposed that U.S. regulators heighten their scrutiny of lenders, mortgage brokers and debt-rating firms to prevent a reoccurrence of the credit crisis roiling capital markets. Writedowns from subprime securities will probably rise to $285 billion, Standard & Poor's said in a report March 13.

``This has become the Bush recession,'' Senator Charles Schumer, a New York Democrat, said on the Fox News program. ``The president's hands-off attitude is reminiscent of Herbert Hoover,'' who led the country from 1929 to 1933.

Bush, under fire from Democrats who say he's doing too little to help homeowners facing foreclosure, yesterday said he won't be stampeded into ``bad policy decisions'' that might harm the economy.

``The market now is in the process of correcting itself, and delaying that correction would only prolong the problem,'' he said in his weekly radio address. ``I believe the government can take sensible, focused action to help responsible homeowners weather this rough patch.''

To contact the reporter on this story: Brendan Murray at brmurray@bloomberg.net
Last Updated: March 16, 2008 11:44 EDT

2007-2009 Bear Market Update

Bear Stearns: The Smoking Gun(s)

There are at least two ways in which a failure at Bear Stear might have precipitated a decimation of the Wall Street financial community: counterparty risk and the triggering of a chain reaction of failures.

First, as of Nov 30, 2007 Bear Stearns was counterparty to 13 TRILLION in derviatives contracts, as shown in their most recent public 10K Filing with the SEC. (hat tip to jerrbear from PrudentBear for tracking down the reference page. Great catch!).

As of November 30, 2007 and 2006, the Company had notional/contract amounts of approximately $13.40 trillion and $8.74 trillion, respectively, of derivative financial instruments, of which $1.85 trillion and $1.25 trillion, respectively, were listed futures and option contracts...

The Company's derivatives had a notional weighted average maturity of approximately 4.2 years at November 30, 2007 and 4.1 years at November 30, 2006. The maturities of notional/contract amounts outstanding for derivative financial instruments as of November 30, 2007 were as follows:

The second method would be a failure at Bear Stearns that triggers a cascade of failures in the Credit Default Swaps (CDS) market. This is not counterparty risk. The risk here is of CDS wagers on the failure of Bear Stearns itself. This market consists of derivative 'wagers' on the credit failure of specific companies. This market has become a leveraged nightmare, being so large that the failure of any single significant company such as Bear Stearns could precipate a chain reaction of defaults. As you may recall we pointed out some time ago that after subprime the next area to watch closely as a potential tipping point would be the CDS market.














Notice that Bear Stearns is not EVEN LISTED as holding derivatives in any of the tables we looked at in the OCC Report. Is this because of their 'non-bank' status? We wonder how many other US corporations are quietly loaded up with derivatives risks as well, either as a large counterparty, or the target of a pyramid of wagers on failure risk many hundreds of times their actual net worth. What a monster Wall Street has created for the world.

Credit Default Swaps: Is Your Fund at Risk?