 | zuchinibut (36)
04/15/2008 | How much more bailing out can our federal government do? Our government is already in debt and needs help, but our spending continues to rise. Spending money which does not exist is a bad trait that Americans posess, and unfortunately it seems our businesses and government spend as foolishly as many individuals.
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 | abichara (60)
03/17/2008 |  The financial markets right now are really at a crossroads. In the case of Bear Stearns, (formerly) one of the more reputable Wall Street firms, the road crosses at two points: either they get bought out by J.P. Morgan, or if the deal falls through, they declare for bankruptcy protection. If they go the bankruptcy route, it will create a global financial panic. I don't expect that the central bankers would allow for such a situation to occur.
The Fed is pumping a lot of new money into the financial system in an attempt to save a lot of these big firms from insolvency. J.P. Morgan and the Fed have also agreed to extend loans to Bear Stearns for 28 days. Stearns was hit the hardest by the sub-prime mortgage crisis. A lot of those mortgage backed securities that they invested in are now worth next to nothing. This is an extraordinary rescue operation on the part of the Fed: they haven't provided such a large bailout since the Great Depression. Their logic is that they're essentially attempting to stem off a much larger global bank crisis. In the case of Stearns, the speculation about their financial health was causing investors to take their money out of the firm or to give up their credit lines--a run on deposits was immediately possible. I think that we might be hearing in the next few days news of other firms in similar dire straits. The big question is whether or not the Fed will throw a lifeline to them as well.
So what makes Stearns so special? It is relatively small, especially in comparison to other Wall Street firms, so why is it such a large threat to the system? Since the 1990's, the markets have been based on a "structured finance" model which has changed the way that institutions and investors interact with each other. The focus is now on maximizing profits by creating a huge variety of debt-based instruments that increase overall risk and creates volatility during bad market conditions like we're seeing today. Derivatives trading, which according to some sources exceeds $500 trillion (!) has connected together various banks and investment institutions in a way that one bank failure can create a domino effect in the market, where the entire financial system could presumably collapse. That was why the Fed got involved when they did: they were attempting to stave off a global financial meltdown.
But why would J.P. Morgan want to buy Bear Stearns, a company whose earnings streams are fairly undiversified and based largely on bad mortgage backed securities? They've had to write up nearly $2.75 billion in losses, and that's just the beginning. It's simple really; essentially, by flooding liquidity into the system, the Fed is guaranteeing that it will take up any of the losses associated with Bear Stearns in the immediate future. Is that correct? Is that how a true free market should operate and will this stem off another recession? I'm not too certain about that. The Federal Reserve would rather usher in global hyperinflation than let a few big banks go under. All that liquidity that the Fed is pumping into the system is causing prices to go up primarily because it weakens the dollar. There is a bit of a moral hazard here indeed. Take gas prices for instance: despite the fact that the market is awash in supply, gas prices are higher than ever. You would normally expect that extra supply would lower prices, but the market isn't operating properly because of bad monetary policy. Should the taxpayer have to pay for the bad decisions that some firms made when they didn't properly underwrite their risk? Sometimes the best thing to do is to bite the bullet, let those firms that underperformed go to the wayside and let the market recover. By providing such bailouts, the Fed is only postponing the inevitable slide towards recession. Although inflation hasn't yet reared its ugly head yet, I expect that we may begin to start seeing it within the year at most.
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