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Bailing out Bear Stearns

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Bailing out Bear Stearns

Economy

Bailing out Bear Stearns

Bailing out Bear Stearns

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  • <iframe src="https://www.npr.org/player/embed/88402823/88402812" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
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J.P. Morgan bought its collapsing rival Bear Stearns after the Federal Reserve intervened. The Fed took several unusual moves, including approving the purchase over the weekend instead of waiting until a March 18 scheduled meeting.

ALEX COHEN, host:

From the studios at NPR West, this is DAY TO DAY. I'm Alex Cohen.

ALEX CHADWICK, host:

I'm Alex Chadwick. Our big story today is the economy and efforts to stabilize it. We're going to spend the first part of the program here.

COHEN: Let's start with the latest twist in the story on Wall Street this morning. The Federal Reserve took extraordinary action over the weekend to try to reassure shaky financial markets.

CHADWICK: This came after one of Wall Street's biggest investment banks - that's Bear Stearns - essentially collapsed over the weekend.

A rival bank, JP Morgan Chase will buy Bear Stearns for the price of two dollars a share. The Fed also cut its emergency lending rate by a quarter of a percent, an action that came a surprising two days earlier than expected.

COHEN: For more, we go now to NPR's Scott Horsley.

Scott, thanks for joining us, and tell us - the Fed working on a Sunday. What exactly are they up to?

SCOTT HORSLEY: That's right, Alex. This was unusual in a couple of respects. One is they did take this action over the weekend. As Alex says, they had a regularly scheduled meeting set for tomorrow, but they didn't want to take the risk of waiting that long to act.

In addition, they're opening the discount window. That's the loans they'll make directly to banks, but not just to commercial banks as usual but also to securities dealers, which is something they haven't done since the Great Depression. The Fed is trying to prevent the credit crunch from turning into a complete credit freeze.

COHEN: And the Fed says it wants to maintain the orderly functioning of financial markets, but it seems, Scott, that there was nothing too orderly about the collapse of Bear Stearns.

HORSLEY: No, this was really a spectacular meltdown. Bear Stearns, one of the biggest investment banks on Wall Street, 85 years old. Last week there had been rumors that the bank was in trouble and on Friday it had to get a lifeline from JP Morgan Chase and the Fed. Its stock lost about half its value on Friday and most of the rest over the weekend. It was really a stunning collapse.

What we saw with Bear Stearns was really a classic run on the bank. I mean, you can picture Jimmy Stewart there in the savings and loan trying to fend off nervous depositors. Only with Bear Stearns it wasn't depositors; it was trading partners and hedge funds that were getting nervous about doing business and its cash just pretty much evaporated. And by late Friday it was teetering on the brink of bankruptcy.

COHEN: So how does the Fed hope to fix this?

HORSLEY: Well, the Fed has, first of all, approved the takeover of Bear Stearns by JP Morgan Chase. It approved the financing, and in fact the Fed is backstopping JP Morgan's purchase and guaranteeing some of Bear Stearns' business. So essentially the taxpayers are on the hook to some extent in this takeover and may pay a price for some of Bear Stearns' bad debts. But the Fed just felt like they couldn't take the risk of having Bear Stearns, which has hooks in so many corners of the financial market, not just go bankrupt but go bankrupt so quickly. That would have caused just unknowable trouble.

COHEN: The credit crunch, of course, began with the meltdown of the subprime mortgage market. Is this still all about mortgages or is there something else at play?

HORSLEY: What it really is is a loss of liquidity, and that means not just the volume of money that's floating around the financial markets but also confidence. The financial writer Jim Grant once described liquidity as the expectation that everything will go right. And that's really the way the credit markets were functioning not so awful long ago. That's why banks were willing to make these risky loans to subprime borrowers.

Now that has all turned around. The pendulum has swung. People no longer expect everything to go right. They're worrying about what might go wrong, and there's a big financial gut check going on. Some of that is healthy, but if the credit dries up too much, too fast, the gut check becomes a bleeding ulcer. And that's what the Fed is trying to prevent here.

COHEN: NPR's Scott Horsley.

Thanks, Scott.

HORSLEY: My pleasure.

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Fed's Moves Highlight Fragile State of Markets

Stock traders negotiate in Sao Paolo Monday morning. Brazil's stock market dropped amid fears the global credit crisis that sank Bear Stearns would spread. hide caption

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Stock traders negotiate in Sao Paolo Monday morning. Brazil's stock market dropped amid fears the global credit crisis that sank Bear Stearns would spread.

Listener Q&A

It's no easy task to keep up with all the intricacies of the housing crisis, the credit crunch and the rest of the economy's doldrums. NPR's Adam Davidson and former Federal Reserve governor Laurence Meyer answer listeners' questions.

The Federal Reserve took dramatic measures over the weekend to reassure the increasingly anxious investment community, including negotiating the bargain-basement sale of Bear Stearns, one of Wall Street's biggest and most storied banks. The Fed's moves raise questions about just how deep the financial industry's woes go — and what other banks might be at risk.

Here, a look at what happened and what it means for the markets:

What was the Fed's role in the sale of Bear Stearns to JP Morgan?

The Fed extended JPMorgan Chase a $30 billion credit line to help it buy rival Bear Stearns, a firm with an 85-year history on Wall Street that was on the verge of collapsing due to losses in the mortgage market. JPMorgan is getting Bear Stearns for the rock-bottom price of about $2 a share — or about $236 million. That's a stunningly low price when one considers that Bear Stearns' shares were trading at $30 each on Friday, and that its company headquarters building in New York is valued at $1 billion by itself.

Why did Bear Stearns agree to be purchased for such a fire-sale price?

Bear Stearns really had no choice. The bank is facing an onslaught of rumors about its losses in the mortgage industry, and on Friday it reported some major liquidity problems — investors were pulling their money out and the bank was short on cash. The only way for Bear Stearns to keep doing business was to let itself be bought by another firm like JPMorgan. But the deal effectively wipes out most of Bear Stearns' shareholder wealth, and it's not clear whether it will win shareholders' approval.

What about customers of Bear Stearns? Will their investments be affected?

Bear Stearns customers will become customers of JPMorgan Chase. Their accounts will transfer automatically; they don't have to do anything, says Laurence Meyer, a former Federal Reserve governor.

What would have happened if the government had not stepped in and instead allowed Bear Stearns to go bankrupt?

Bear Stearns doesn't just have its own assets — it serves as what's called a "counterparty," meaning it works as the middleman for billions of dollars in transactions. So, working people have retirement funds there, for example, and smaller banks and hedge funds can trade stocks or securities through Bear Stearns.

If the bank did go bankrupt, an unbelievably long and complex legal process would begin. Thousands of Bear Stearns customers — from individual retirees to massive hedge funds — would have huge amounts of money just frozen. Imagine how complicated a personal bankruptcy is and multiply that by tens of billions of dollars in assets. The Federal Reserve wanted to avoid that.

What other measures did the Fed take?

Perhaps the Fed's most significant move over the weekend was the creation of a new program to give emergency loans directly to the 20 largest so-called "primary dealers." These are investment banks that do business directly with the Fed and which purchase the majority of Treasury securities.

In addition, the Fed lowered the discount-lending rate — that's the rate which it charges banks for very short-term loans — by a quarter-point, to 3.25, on Sunday. It followed that on Tuesday with a cut of three-quarters of a percentage point to another key interest rate, the federal funds rate.

Why did the Fed feel the need to take such dramatic action?

It's an indication of just how precarious things are in the financial markets. The fear is that if an investment giant like Bear Stearns fails, it could spark a run on other banks with sizable exposure to troubled credit markets, creating a domino effect of defaults.

Investment banks like Bear Stearns are the lifeblood of capital markets, providing the cash flow that keeps economic gears turning. They facilitate short-term loans to businesses, raise money for corporate expansions and IPOs and assist the trading of securities. Without them, financial markets would grind to a halt.

Does the Fed's intervention mean that things might be worse on Wall Street than they appear?

It certainly feeds those suspicions. The current credit crisis is largely being fueled by fear and uncertainty. Because they are not traded on a daily basis, mortgage-backed securities are difficult to value even in the best of times. Now that the mortgage market is in free fall, it's almost impossible to gauge just how much bad debt these banks have been left holding. That has made banks extremely nervous about making even short-term loans to each other.

Are other banks in serious trouble?

Yes, and everyone is asking who's most at risk. Some of the names mentioned most frequently are UBS and Lehman Brothers, both of which have a lot of exposure to subprime and mortgage-related securities.

Why do the markets feel comfortable with the Fed actions to help JPMorgan buy Bear Stearns, but not with government action to provide relief to homeowners who cannot pay their mortgages?

Actually, the Fed's action is quite controversial. "People do worry about moral hazard, although I think that Bear Stearns was significantly punished," says former Fed governor Meyer. The Fed has taken credit risk onto its portfolio that it wasn't really set up to do, but global investment banks are really too big to simply go out of business, he adds.

But when it comes to homeowners, it's important to understand that there are actions the Federal Reserve can take, and actions that the administration and Congress would have to handle. Helping out homeowners is up to the latter. "Again, there's moral hazard issues as to whether you should do that," Meyer says. "But the problem is so significant here ... I think you could reasonably argue that it is a time for [the Treasury Department] and the administration to put some taxpayers' money at risk here, in order to reduce the risks ... and help homeowners."

With reporting by NPR's Jim Zarroli, Chris Arnold, Adam Davidson and Uri Berliner

JP Morgan Snaps Up Bear Stearns for $2 a Share

JP Morgan Chase will acquire the troubled investment bank Bear Stearns at the fire-sale price of $2 a share, a deal quickly approved over the weekend by the Federal Reserve, which aims to keep the financial giant from collapsing from its losses in the subprime mortgage crisis.

The approval came as the Fed also took the extraordinary step Sunday of lowering its emergency lending rate to financial institutions by a quarter-point to 3.25 percent.

The moves, days before the Feds scheduled meeting Tuesday, smacked of desperation to many investors, stirring fear worldwide that other banks with sizable exposure to troubled credit markets could also implode. Stocks fell sharply in Asia and Europe, and oil prices set fresh records in Asian trading.

Stunned dealers and traders at Bear Stearns turned up for work Monday to find the value of their stock options in tatters and the future of their jobs up in the air. Just last year, Bear Stearns stock was trading at $172 a share, although it had plunged to $30 in recent days amid market rumors that the bank was heavily exposed to subprime losses.

JP Morgan Chief Financial Officer Michael Cavanagh did not say what would happen to Bear Stearns' 14,000 employees worldwide, or whether the 85-year-old Bear Stearns name would live on after surviving the Great Depression and a slew of recessions.

JP Morgan said it will guarantee all business — such as trading and investment banking — until Bear Stearns' shareholders approve the deal, expected to be completed during the second quarter. The acquisition includes Bear Stearns' midtown Manhattan headquarters.