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March 16, 2008
When was the last time the Fed made a policy announcement on a Sunday?
I do not know the answer to my title question, but if anyone does, I am curious. Anyway, here is the announcement from the Fed, and this is the first in what will be at least two posts on the subject by me tonight. If it were just one post, it would be far too long. So let's get started.
This story starts as a bank run... not like the one in It's a Wonderful Life, but a run on an investment bank. Less of a public spectacle, but just as nerve-wracking. (NY Times)
Just three days ago, the head of Bear Stearns, the beleaguered investment bank, sought to assure Wall Street that his firm was safe.
But those assurances were blown away in what amounted to a bank run at Bear Stearns, prompting JPMorgan Chase and the Federal Reserve Bank of New York to step in on Friday with a financial rescue package intended to keep the firm afloat.
...
The developments may only postpone the eventual sale of all or part of Bear Stearns, which has had crippling losses on mortgage-linked investments. To keep the 85-year-old firm solvent, JPMorgan, backed by the New York Fed, extended a secured line of credit that gives Bear Stearns at least 28 days to shore up its finances or, more likely, to find a buyer.
Comment #1: This article is from yesterday--March 15. The sale of Bear Stearns will probably be consummated tonight. That is an indication of just how quickly these things are moving. So quickly that the financial reporters who spend their days enmeshed in these stories are underestimating how rapidly the events will unfold.
News of the bailout ignited fears that other big banks remain vulnerable to the continuing credit crisis, and stocks tumbled in another rocky day for the markets. Financial shares led the way, with shares of Bear Stearns plunging 47 percent. Hours after the rescue was announced, another Wall Street firm, Lehman Brothers, said it had secured a three-year credit line from banks. Its stock fell 15 percent.
Comment #2: Counterparty risk and systemic risk--look them up.
The Fed’s intervention highlights the problems regulators face as they contemplate the prospect that investment banks, saddled with toxic securities tied to subprime mortgages, are losing the trust of their lenders and clients — the kiss of death on Wall Street, where confidence has always been the most precious asset of all.
Traditionally regulators have helped commercial banks in financial panics, but not investment banks, which do not hold customer deposits. But the 1999 repeal of the Glass-Steagall Act, the Depression-era law that separated investment banks and commercial banks, led to consolidation within the financial industry that has made such distinctions harder to make.
“I don’t remember a Fed action aimed at a noncommercial bank; this is the kind of thing you see in this post-regulatory environment,” said Charles Geisst, a Wall Street historian at Manhattan College.
Comment #3: Indeed this is a sign of our times. The consequences of investment bank versus commercial bank failure are different and so are the reasons for rescuing them. In the movie It's a Wonderful Life, when the Bailey Building and Loan faces a bank run, the deposits of the townspeople (the "little guys", if you will) are directly at risk. But when Bear Stearns cannot meet its obligations to its creditors (who are anything but "little guys"), it means that those creditors may face difficulty in meeting their obligations. Eventually, as the crisis deepens, it will begin to threaten commercial banks that do have more of a connection to "real people" with deposits that FDIC will make sure are protected. Certainly that is the worst-case scenario that everyone wants to avoid.
So did the Fed do the right thing by intervening? There are many reasons to say yes, but not everyone thinks so. This post is getting long, and a full answer to this question deserves it's own. To be continued...
UPDATE: John Jansen informs us that October 6, 1979 was a Saturday. Close enough. Students of monetary policy need only read the date to know what that was about.
Posted by William Polley at March 16, 2008 7:53 PM
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Comments
I am not 100 percent sure but I think I recall that the Paul Volcker October Revolution in 1979 was hatched over a weekend. And I do not recall any other over the intervening 29 years.
JJJ
Posted by: john jansen at March 17, 2008 1:24 AM
http://research.stlouisfed.org/publications/review/05/03/part2/Black.pdf
it looks like oct ober 6 1979 was a weekend
Posted by: john jansen at March 17, 2008 1:29 AM
http://research.stlouisfed.org/publications/review/05/03/part2/Black.pdf
it looks like october 6 1979 was a saturday
Posted by: john jansen at March 17, 2008 1:30 AM