One piece of wisdom I picked up living in Quebec for 13 years is the following aphorism, in my best translation to English … “You can’t $#|+ higher than your a$$hole.”
So very, very true in the world of finance, and decidedly applicable in the event.
This is not the end. The scientist in me simply has to point out that economic events do [i]not[/i] work as a Gaussian distribution, but as a power distribution. In very practical terms it means that events anticipated to be incredibly unlikely — like once in 50,000 years — may actually occur, not only many orders of magnitude more frequently, but also in clusters.
Our economic hubris is being punished by the reality of a power curve. This is the time to transfer assets from weaker hands into stronger ones. That is healthy, and should be welcomed, even if it results in significant consternation. JP Morgan have been strong hands for a very long time.
— The costs of failure will fall mostly on Bear Stearns shareholders, the people who selected the firm’s managers and who stood to gain if the firm’s bets had paid off
Irenaeus, maybe it is a little too early to be so smug about this economic crisis. A falling tide lowers all ships. By the time this works its way out your own house on the open market may only be worth 2/70th of what it is today.
Following on from [1], apparently declaring Bear Stearns as fifth largest was inaccurate, perhaps a paper fiction, since their current actual worth on the market is now closer to $2. Again following on from [1], the real (marketable) value as opposed to the optimistic reported value of a number of financial houses may also be much lower than is now known or supposed. As others continue to fall, we may see major reshuffling of who is big, and of course, who is even left.
It continues to amaze me that the financial industry and the people that needed their services (such as mortgages) thought that they were clever enough to have discovered a really good new way to finance something that nobody else was ever clever enough to invent. Risk, return, liquidity – what part of this did people think they could violate and not find themselves on the wrong side of foreclosure (for individuals) or corporate catastrophe (for those holding the loans). Greed is a sin, and as Augustine, Calvin and many others have said, sin causes blindness and unclear thinking. Nothing new here. Of course, some seeking to finance a home have been caught by greedy lenders, but believing a loan originator who tells you something that sounds too good to be true seems to have been part of the blindness.
The cluster effect that [1] describes may be a statistical result of the herd mentality involved with something such as the ARM craze. I suspect that if there had been an executive at some financial business who said several years ago that ARMS were a bad idea and that they should avoid them, he or she would have been fired for poor performance. Just another way that the sin of greed can cloud rational thinking.
David [#3]: I’m being neither smug nor complacent.
Over the past several years I have repeatedly warned that lenders have become insouciant about credit risk—the risk that borrowers will default on their loans.
So much for complacency. The smugness is your own projection. For this acquisition is good news. A prominent firm that was in free fall just a couple of days ago is now in strong hands. All its creditors will get paid. Its good assets can be put to good use. Its bad assets can be sold or liquidated in an orderly way.
Irenaeus, I believe we are just at the beginning of a tidal wave that will affect me and you – no matter how prudent we have tried to be. I pray we will be able to keep our heads above water as the mountain of debt society has built up collapses around us.
Alan Greenspan has a piece in today’s Financial Times in which he agrees that we are in for some rough times in the short run–but not endless freefall. He notes that markets tend to go from euphoria to deep depression without a whole lot in between. Just because the markets panic today, it doesn’t mean that we should, too.
During the housing bubble, many people couldn’t afford to buy even a modest home. That is changing–and as those formerly frozen out of the housing market are able to buy, the extra inventory will be used up, and prices will start to rise again. We may not see the peak prices of 2006 again, but we shouldn’t assume that prices will keep falling forever.
I’m heartened at the collapse of B-S, given the mismanagement of its assets. It’s just another failed company, like Pan-Am or Eastern. I hope JPM cleans house.
I wouldn’t bet the ranch on JPM. Estimates of derivatives exposure ranks it well up there. And recent experience with JPM does not find that it is operating very smoothly.
Inrenaus, your statement: “The costs of failure will fall mostly on Bear Stearns shareholders . . .”. True, but many of those were not individuals but pension funds and mutual funds, maybe your’s and mine?
I agree with #9. The opposite of “irrational exuberance” is not “rational evaluation” but “irrational doomsaying.” One thing I learned at my 11 years at Merrill Lynch — what everybody just KNOWS is going to happen, is almost certainly not going to happen — on the way up as on the way down.
CharlesB [#12]: I invest much of my savings in index mutual funds. Bear Stearns was part (albeit a small part) of the S&P;500, the Russell 1000, and the DJ-Wilshire 5000, so I will bear part of the loss. That’s life in the stock market. All investors stand to gain from getting Bear’s problems resoved.
I do feel badly for Bear Stearn’s line employees, who did not create the problem, did not reap big profits from it, and now stand to lose their jobs.
MargaretG [#13]: Bear Stearns had accounted for some 0.3% of the combined market capitalization of the S&P;500, so its failure will in itself have minimal effect on well diversified pension funds and endowments. The big question is how the rest of the financial sector fares, including how deeply the bad-credit rot extends.
Irenaeus, your analysis leaves out the BIG news: Yes, JPM purchased much of the stock of Bears. HOWEVER, read further: JPM REFUSED to pick up many of the outstanding debts of Bears. Guess who is picking up the loser side of the ledger??? The Feds — that is, the US taxpayer. JPM cherry-picked, and good for them!
The sainted ‘market forces’ imploded, and it is not only Bears investors who are burned. The investment banks were allowed to slice and dice mortgages and other ‘investment vehicles’ with very little or not regulation. Result: the big CEOs and managers pulled in enormous profits, and the little guys (all US taxpayers, that is) are burned. Once again.
They worked all weekend on this, and announced it Sunday night before the Asian markets opened. Why? Because the Feds did not dare allow Bears to go under, it would have created a cascade of runs on the other investment banks. Our deficit has increased 70% under this Administration (with daily more going down the rathole in Iraq), and the chickens are coming home to roost. It’s stunning that this would happen under a Republican administration. The next President will reap the whirlwind — and the rest of us will be shredded. Period.
Little Cabbage –the “sainted market forces” didn’t implode–they did just what they were supposed to do, which was to correct the market by ending the housing bubble.
You will be happy to know that nowadays, the little guy isn’t much of a taxpayer. The bottom fifty percent in income pay something like 5% of total Federal income taxes paid, while the top 1% (which includes a lot of the CEOs and managers) pays almost 40% of the total take. So the culprits will be bearing a big part of the burden–as indeed they should.
Sorry, pal, but most of us simply don’t feel the fat cats’ ‘pain’. I don’t see them losing their homes, or their big cars, or their jobs, or their children’s college education. The total (including FICA) tax bite on working Americans runs about 40%. The middle class has been barely able to hang on by sending mom to work; now it’s rapidly losing ground. The little guys will be paying for the GOP Bush mess, and so will our grandchildren.
And thankfully, the voting public seems at last to be waking up to that fact.
As for the ‘implode’ — you still don’t address the fact that JPM was allowed to (rightfully) cherry-pick. The market forces WERE NOT allowed to work. It was one more example of a partially-controlled market. If ‘market forces’ had been given free rein, it would have been a disaster: Bears would have gone under; JPM would have been forced to accept the enormous bad debts of Bears; and the run on the investment banks would have continued. Funny how the fat cats hate regulation, but insist that they be bailed out because ‘if you let us go, we all go down’. Same old same old.
It is still stunning that all this economic mess (including the deficit and resulting weak dollar) all happened on the GOP watch!
Little Cabbage—In 2005, the total federal tax bite on the middle class (including FICA) was 14.2%, down from 16.6% under Clinton. http://blogs.wsj.com/economics/2007/12/12/a-bigger-tax-bite
Property taxes and state taxes vary from place to place, but even in NY-NJ.where these taxes are among the highest in the nation, the total cut would still be under 25%–a lot less than the 40% you claim. I’m also curious about where you read that the middle class is “rapidly losing ground.” And I feel pretty safe in saying that there will be lots of pain to spread around on Wall Street–jobs lost, careers ended, plenty of people having to downsize their lives. How long do you think it will be before the layoffs from Bear Stearns start?
I agree that the level of spending during this administration has been horrendous. While I disagree with you about the war, there are plenty of other places where both Bush and Congress have been willing to throw money around as if there were no tomorrow.
Bear in mind, though, that the policies advocated by the Democrats-higher taxes and protectionist tariffs–were also used by Herbert Hoover after the ’29 crash–and we know how successful his administration was.
“Guess who is picking up the loser side of the ledger??? The Feds—that is, the US taxpayer”
Little Cabbage [#16]: According to today’s Wall Street Journal, “the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns’s less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn’t describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.”
To my knowledge, the Fed has never, in its 95-year history, incurred a loss on a loan. It has always obtained enough good collateral so that it has received full payment even if the borrower fails. I doubt that the Fed will want to break that record now.
But the Fed evidently is breaking precedent in letting JPM limit its liability. To make that work, I suppose that JPM would purchase Bear’s good assets and the Fed would make a loan to Bear Stearns secured by Bear’s remaining assets. But I haven’t seen details of the transaction.
I would expect that JPM and the Fed marked the problem assets to their estimated market value. We’ll have a better sense of the Fed’s risk exposure once we know what percentage of that value the Fed loaned.
Unfortunately, you are overlooking FICA, which chews up the middle class, but stops at (what is it) about $90,000 of salary…it should have been indexed to start with, the Social Security system would be in much better shape. You also use the old ‘attack the Dems’ model. Yawn. Barry Goldwater must be spinning in his grave to see how the neocons and Bush II have warped GOP values of frugality and balanced budgets.
Of course, you choose not to grasp that nettle — just as the GOP candidates are choosing NOT to run on the ‘Bush legacy’. I don’t blame you, I would do the same when faced with a losing argument. Cheers and Happy St Paddy’s Day to ye.
“The policies advocated by the Democrats-higher taxes and protectionist tariffs–were also used by Herbert Hoover after the ‘29 crash” —In Newark [#19]
The Clinton Administration favored free trade and avoided protectionism. During the year before the 2000 election, Bush pandered to the protectionism sought by the steelworkers’ union; Clinton did not. That may well have tipped West Virginia into the Bush column.
As for taxes, under Clinton the United States had the lowest taxes (measured as a percentage of GDP) of any major industrialized country except Japan.
Little Cabbage–Those numbers INCLUDE FICA. If you read the article I referenced,it makes clear that the 14.2% includes ALL FEDERAL TAXES. I agree that SS taxes are high, but they about 6 or 7%, not 26%!
So far as I know, JPM had to buy all of Bear Stearns—they took on the bad loans in exchange for the very low price, and the limited Federal indemnification that Irenaeus describes above. Also, I just read that Bear Stearns employees own about 1/3 of the company’ stock (bonuses were often paid in stock rather than cash), so they have already sustained substantial losses. And now many of them will lose their jobs, too.
Re: your other points–if the Bush GOP has abandoned their financial principles (and I agree that in many respects they have), it doesn’t make the principles wrong. It also doesn’t make the other party right–especially when they are even more adamant about rejecting sound economics.
Irenaeus– I agree with you, but I wasn’t talking about Bill Clinton. The high tax and tariff solution has been trotted out on more than one occasion by Hillary since she became Senator, and Obama, who wants to abandon NAFTA, has similar ideas. (I’ll also join in your criticism of Bush’s steel tariffs, which were roundly criticized by conservatives at the time).
Nobody’s bouncing NAFTA — it benefits the giant corporations which pay for political campaigns (it’s called ‘campaign fund-raising and it equals legalized bribery).
And please re-read my posts, guys — I never said ‘the other party is right’. I DID point out: A) Whomever is elected Prez is going to be saddled with cleaning up an incredible mess and B) The neocons abandoned GOP fiscal conservatism, and the country is paying for it (and our grandchildren will, too!)
One piece of wisdom I picked up living in Quebec for 13 years is the following aphorism, in my best translation to English … “You can’t $#|+ higher than your a$$hole.”
So very, very true in the world of finance, and decidedly applicable in the event.
This is not the end. The scientist in me simply has to point out that economic events do [i]not[/i] work as a Gaussian distribution, but as a power distribution. In very practical terms it means that events anticipated to be incredibly unlikely — like once in 50,000 years — may actually occur, not only many orders of magnitude more frequently, but also in clusters.
Our economic hubris is being punished by the reality of a power curve. This is the time to transfer assets from weaker hands into stronger ones. That is healthy, and should be welcomed, even if it results in significant consternation. JP Morgan have been strong hands for a very long time.
Good news:
— No government bailout
— No big mess
— The costs of failure will fall mostly on Bear Stearns shareholders, the people who selected the firm’s managers and who stood to gain if the firm’s bets had paid off
Irenaeus, maybe it is a little too early to be so smug about this economic crisis. A falling tide lowers all ships. By the time this works its way out your own house on the open market may only be worth 2/70th of what it is today.
“A falling tide lowers all ships. ”
Except those that have already run aground.
Following on from [1], apparently declaring Bear Stearns as fifth largest was inaccurate, perhaps a paper fiction, since their current actual worth on the market is now closer to $2. Again following on from [1], the real (marketable) value as opposed to the optimistic reported value of a number of financial houses may also be much lower than is now known or supposed. As others continue to fall, we may see major reshuffling of who is big, and of course, who is even left.
It continues to amaze me that the financial industry and the people that needed their services (such as mortgages) thought that they were clever enough to have discovered a really good new way to finance something that nobody else was ever clever enough to invent. Risk, return, liquidity – what part of this did people think they could violate and not find themselves on the wrong side of foreclosure (for individuals) or corporate catastrophe (for those holding the loans). Greed is a sin, and as Augustine, Calvin and many others have said, sin causes blindness and unclear thinking. Nothing new here. Of course, some seeking to finance a home have been caught by greedy lenders, but believing a loan originator who tells you something that sounds too good to be true seems to have been part of the blindness.
The cluster effect that [1] describes may be a statistical result of the herd mentality involved with something such as the ARM craze. I suspect that if there had been an executive at some financial business who said several years ago that ARMS were a bad idea and that they should avoid them, he or she would have been fired for poor performance. Just another way that the sin of greed can cloud rational thinking.
Marie, even a house that is paid off in full will fall in value none the less on the open market if other houses are likewise falling in value.
David [#3]: I’m being neither smug nor complacent.
Over the past several years I have repeatedly warned that lenders have become insouciant about credit risk—the risk that borrowers will default on their loans.
So much for complacency. The smugness is your own projection. For this acquisition is good news. A prominent firm that was in free fall just a couple of days ago is now in strong hands. All its creditors will get paid. Its good assets can be put to good use. Its bad assets can be sold or liquidated in an orderly way.
Irenaeus, I believe we are just at the beginning of a tidal wave that will affect me and you – no matter how prudent we have tried to be. I pray we will be able to keep our heads above water as the mountain of debt society has built up collapses around us.
Alan Greenspan has a piece in today’s Financial Times in which he agrees that we are in for some rough times in the short run–but not endless freefall. He notes that markets tend to go from euphoria to deep depression without a whole lot in between. Just because the markets panic today, it doesn’t mean that we should, too.
During the housing bubble, many people couldn’t afford to buy even a modest home. That is changing–and as those formerly frozen out of the housing market are able to buy, the extra inventory will be used up, and prices will start to rise again. We may not see the peak prices of 2006 again, but we shouldn’t assume that prices will keep falling forever.
I’m heartened at the collapse of B-S, given the mismanagement of its assets. It’s just another failed company, like Pan-Am or Eastern. I hope JPM cleans house.
I wouldn’t bet the ranch on JPM. Estimates of derivatives exposure ranks it well up there. And recent experience with JPM does not find that it is operating very smoothly.
Inrenaus, your statement: “The costs of failure will fall mostly on Bear Stearns shareholders . . .”. True, but many of those were not individuals but pension funds and mutual funds, maybe your’s and mine?
and, more relevant to this blog, TEC’s pensions and endowment funds.
I agree with #9. The opposite of “irrational exuberance” is not “rational evaluation” but “irrational doomsaying.” One thing I learned at my 11 years at Merrill Lynch — what everybody just KNOWS is going to happen, is almost certainly not going to happen — on the way up as on the way down.
CharlesB [#12]: I invest much of my savings in index mutual funds. Bear Stearns was part (albeit a small part) of the S&P;500, the Russell 1000, and the DJ-Wilshire 5000, so I will bear part of the loss. That’s life in the stock market. All investors stand to gain from getting Bear’s problems resoved.
I do feel badly for Bear Stearn’s line employees, who did not create the problem, did not reap big profits from it, and now stand to lose their jobs.
MargaretG [#13]: Bear Stearns had accounted for some 0.3% of the combined market capitalization of the S&P;500, so its failure will in itself have minimal effect on well diversified pension funds and endowments. The big question is how the rest of the financial sector fares, including how deeply the bad-credit rot extends.
Irenaeus, your analysis leaves out the BIG news: Yes, JPM purchased much of the stock of Bears. HOWEVER, read further: JPM REFUSED to pick up many of the outstanding debts of Bears. Guess who is picking up the loser side of the ledger??? The Feds — that is, the US taxpayer. JPM cherry-picked, and good for them!
The sainted ‘market forces’ imploded, and it is not only Bears investors who are burned. The investment banks were allowed to slice and dice mortgages and other ‘investment vehicles’ with very little or not regulation. Result: the big CEOs and managers pulled in enormous profits, and the little guys (all US taxpayers, that is) are burned. Once again.
They worked all weekend on this, and announced it Sunday night before the Asian markets opened. Why? Because the Feds did not dare allow Bears to go under, it would have created a cascade of runs on the other investment banks. Our deficit has increased 70% under this Administration (with daily more going down the rathole in Iraq), and the chickens are coming home to roost. It’s stunning that this would happen under a Republican administration. The next President will reap the whirlwind — and the rest of us will be shredded. Period.
Little Cabbage –the “sainted market forces” didn’t implode–they did just what they were supposed to do, which was to correct the market by ending the housing bubble.
You will be happy to know that nowadays, the little guy isn’t much of a taxpayer. The bottom fifty percent in income pay something like 5% of total Federal income taxes paid, while the top 1% (which includes a lot of the CEOs and managers) pays almost 40% of the total take. So the culprits will be bearing a big part of the burden–as indeed they should.
Sorry, pal, but most of us simply don’t feel the fat cats’ ‘pain’. I don’t see them losing their homes, or their big cars, or their jobs, or their children’s college education. The total (including FICA) tax bite on working Americans runs about 40%. The middle class has been barely able to hang on by sending mom to work; now it’s rapidly losing ground. The little guys will be paying for the GOP Bush mess, and so will our grandchildren.
And thankfully, the voting public seems at last to be waking up to that fact.
As for the ‘implode’ — you still don’t address the fact that JPM was allowed to (rightfully) cherry-pick. The market forces WERE NOT allowed to work. It was one more example of a partially-controlled market. If ‘market forces’ had been given free rein, it would have been a disaster: Bears would have gone under; JPM would have been forced to accept the enormous bad debts of Bears; and the run on the investment banks would have continued. Funny how the fat cats hate regulation, but insist that they be bailed out because ‘if you let us go, we all go down’. Same old same old.
It is still stunning that all this economic mess (including the deficit and resulting weak dollar) all happened on the GOP watch!
Little Cabbage—In 2005, the total federal tax bite on the middle class (including FICA) was 14.2%, down from 16.6% under Clinton.
http://blogs.wsj.com/economics/2007/12/12/a-bigger-tax-bite
Property taxes and state taxes vary from place to place, but even in NY-NJ.where these taxes are among the highest in the nation, the total cut would still be under 25%–a lot less than the 40% you claim. I’m also curious about where you read that the middle class is “rapidly losing ground.” And I feel pretty safe in saying that there will be lots of pain to spread around on Wall Street–jobs lost, careers ended, plenty of people having to downsize their lives. How long do you think it will be before the layoffs from Bear Stearns start?
I agree that the level of spending during this administration has been horrendous. While I disagree with you about the war, there are plenty of other places where both Bush and Congress have been willing to throw money around as if there were no tomorrow.
Bear in mind, though, that the policies advocated by the Democrats-higher taxes and protectionist tariffs–were also used by Herbert Hoover after the ’29 crash–and we know how successful his administration was.
“Guess who is picking up the loser side of the ledger??? The Feds—that is, the US taxpayer”
Little Cabbage [#16]: According to today’s Wall Street Journal, “the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns’s less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn’t describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.”
To my knowledge, the Fed has never, in its 95-year history, incurred a loss on a loan. It has always obtained enough good collateral so that it has received full payment even if the borrower fails. I doubt that the Fed will want to break that record now.
But the Fed evidently is breaking precedent in letting JPM limit its liability. To make that work, I suppose that JPM would purchase Bear’s good assets and the Fed would make a loan to Bear Stearns secured by Bear’s remaining assets. But I haven’t seen details of the transaction.
I would expect that JPM and the Fed marked the problem assets to their estimated market value. We’ll have a better sense of the Fed’s risk exposure once we know what percentage of that value the Fed loaned.
Unfortunately, you are overlooking FICA, which chews up the middle class, but stops at (what is it) about $90,000 of salary…it should have been indexed to start with, the Social Security system would be in much better shape. You also use the old ‘attack the Dems’ model. Yawn. Barry Goldwater must be spinning in his grave to see how the neocons and Bush II have warped GOP values of frugality and balanced budgets.
Of course, you choose not to grasp that nettle — just as the GOP candidates are choosing NOT to run on the ‘Bush legacy’. I don’t blame you, I would do the same when faced with a losing argument. Cheers and Happy St Paddy’s Day to ye.
“The policies advocated by the Democrats-higher taxes and protectionist tariffs–were also used by Herbert Hoover after the ‘29 crash” —In Newark [#19]
The Clinton Administration favored free trade and avoided protectionism. During the year before the 2000 election, Bush pandered to the protectionism sought by the steelworkers’ union; Clinton did not. That may well have tipped West Virginia into the Bush column.
As for taxes, under Clinton the United States had the lowest taxes (measured as a percentage of GDP) of any major industrialized country except Japan.
Little Cabbage–Those numbers INCLUDE FICA. If you read the article I referenced,it makes clear that the 14.2% includes ALL FEDERAL TAXES. I agree that SS taxes are high, but they about 6 or 7%, not 26%!
So far as I know, JPM had to buy all of Bear Stearns—they took on the bad loans in exchange for the very low price, and the limited Federal indemnification that Irenaeus describes above. Also, I just read that Bear Stearns employees own about 1/3 of the company’ stock (bonuses were often paid in stock rather than cash), so they have already sustained substantial losses. And now many of them will lose their jobs, too.
Re: your other points–if the Bush GOP has abandoned their financial principles (and I agree that in many respects they have), it doesn’t make the principles wrong. It also doesn’t make the other party right–especially when they are even more adamant about rejecting sound economics.
Irenaeus– I agree with you, but I wasn’t talking about Bill Clinton. The high tax and tariff solution has been trotted out on more than one occasion by Hillary since she became Senator, and Obama, who wants to abandon NAFTA, has similar ideas. (I’ll also join in your criticism of Bush’s steel tariffs, which were roundly criticized by conservatives at the time).
Nobody’s bouncing NAFTA — it benefits the giant corporations which pay for political campaigns (it’s called ‘campaign fund-raising and it equals legalized bribery).
And please re-read my posts, guys — I never said ‘the other party is right’. I DID point out: A) Whomever is elected Prez is going to be saddled with cleaning up an incredible mess and B) The neocons abandoned GOP fiscal conservatism, and the country is paying for it (and our grandchildren will, too!)