- The Washington Times - Tuesday, March 18, 2008

ANALYSIS/OPINION:

In the immediate aftermath of the desperate measures taken over the weekend by Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson to mitigate the worldwide financial repercussions following the collapse of Bear Stearns, the nation’s fifth-largest investment bank, Japan’s Nikkei 225 stock index shed nearly 4 percent of its value yesterday, closing below 11,800. To those who are understandably worried that the wrong policy responses to the bursting of America’s housing bubble could unintentionally produce the “lost decade” comparable to Japan’s economic experience after its property and stock-market bubbles burst in 1990, it is worth pointing out that the Nikkei 225, nearly two decades after peaking in late 1989, is still 70 percent beneath its pre-bubble-bursting level of nearly 40,000.

Clearly, at this moment, it is impossible to know whether the unprecedented actions taken in the post-Great Depression era by the Federal Reserve Board and the U.S. Treasury over the weekend will prove to be successful in addressing the rapidly evolving, increasingly intensifying crises in the financial, credit and housing markets in America and throughout much of the world. On the other hand, we may now conclude with certainty that the Fed and Treasury are now operating in full-blown-panic mode. And that is not to say that policy-makers will not become much more panic-stricken in the weeks and months ahead. They almost certainly will, such are the financial challenges that confront the policy-makers.

As recently as early last year, Bear Stearns’ market capitalization (its stock price of $171.50 per share multiplied by its 133 million common shares outstanding) approached $23 billion. At the end of its fiscal year in November, following the first quarterly loss in its 85-year history, Bear Stearns had nearly $12 billion in stockholders’ equity and a book value of $84 per share. Earlier this month, the share price was still north of $75; and even after Bear’s stock plunged $27 per share on Friday to close at $30, the company’s market cap was still $3.5 billion. By Sunday, however, Wall Street’s confidence in Bear Stearns had plunged to such depths that JPMorgan Chase, assisted by an unprecedented $30 billion in financing from the Fed, bought the investment bank for a reported $236 million — about $2 a share, or an amount that is less than a quarter of the value of Bear’s $1 billion midtown Manhattan building.

The Fed extended its $30 billion advance not to bail out Bear Stearns shareholders, whose stock value has effectively been obliterated. Rather, with the backing of Mr. Paulson, the Fed acted in a desperate attempt to prevent the collapse of Bear Stearns from unleashing an onslaught of negative repercussions that could reverberate throughout the interconnected financial markets. In addition to orchestrating and financing JPMorgan Chase’s fire-sale purchase of Bear Stearns, the Fed announced on Sunday night that it would take the extraordinary step of making direct loans to other investment banks, a step it has not taken since the Great Depression. Moreover, the Fed has agreed to accept as collateral the very same subprime-mortgage securities that had been falling in value and whose prices are now difficult to gauge because the market has frozen.

Today, the Fed is expected to lower the federal-funds rate by as much as 1 percentage point. That is the interest rate that banks charge each other for mostly overnight loans. The Fed has already chopped 2.25 percentage points from the fed-funds rate since mid-September, when it stood at 5.25 percent. Today’s action could lower it from 3 percent to 2 percent.

It is fitting that the roots of the Bear Stearns financial meltdown can be traced to the implosion of two Bear Stearns hedge funds that suffered huge losses last June related to its bad bets in the subprime-mortgage market. Those losses precipitated the subprime crisis that has afflicted Wall Street ever since. And it shows no signs of letting up. Indeed, what began in the market for subprime mortgages has spread throughout the mortgage market and into municipal-bond, student-loan and other credit markets.

As an increasingly popular refrain puts it: “We’re all subprime now.” That’s a phrase that is easily understood today by Messrs. Bernanke and Paulson, both of whom seriously underestimated the severity of the housing crisis.

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