We usually don’t hear about bank failures too often. If one does go under, it seems like it’s usually a small, rural one. The bank gets into trouble, it goes illiquid, is closed by the local state banking commission, and it’s assets are taken over by a larger institution. No one outside of the affected parties worry if the East Overshoe Savings & Loan goes under… it’s a different story when the dying institution is one of the bulwarks of Wall Street.
In case you hadn’t noticed, Bear Stearns is on life support… staying afloat thanks only to injections from JP Morgan, courtesy of the New York Fed. The Fed is graciously allowing Morgan to pump cash into Bear to keep it afloat using “AAA mortgage securities” (insert your own joke here) from Bear as collateral. Bear Stearns isn’t a proper bank, so they are not eligible to go to the Fed directly for help. Long story short, Bear Stearns was one of the bigger investment houses to bet heavily on subprime mortgages, and now that they are finding out that those toxic notes are worth less than last week’s lottery tickets.
The whole idea behind the free market is that a firm or individual takes risks. If these risks pay off, the risk-takers are rewarded. If it doesn’t, then the betting party takes it’s lumps during what can be politely described as a ‘learning moment.’ Well, in Bear Stearns’ case, the company is large enough and the risks it took were big enough that Wall Street is scared out of it’s collective gourd and has determined that the institution must be saved at all costs.
The prospects of failure at Bear and other large banks and/or investment companies is why the Fed has recently changed it’s rule and is taking in subprime mortgage debt in exchange for cash. According to the plan, the Fed will take in mortgage-backed paper and hold it for 28 days or so until ‘market conditions improve.’ Even if the stuff they are taking in is top-shelf quality, what exactly do they see improving in the housing market in the next month?
For what it’s worth, while subprime mortgages aren’t doing well, neither is the dollar. A cynical amateur internet hack could say that the Fed is basically taking in a load of crap that is declining in value and lending out the exact same thing.
This bear isn’t out of the woods yet, and odds are good it may have more company sooner or later. Stay tuned…