Bear Stearns and Bush Speech

Another quick interruption of the main theme for comment on the news of the day.

This morning, JP Morgan and Chase and the Fed of NY announced a "bail-out" for Bear Stearns. Forty-eight hours ago, the Bear CEO was assuring CNBC that everything at Bear was great and there were no problems. Another indication that financial institutions are approaching panic?

OK...the way I see it, is that the financial markets are now in an "unraveling" phase - i.e. they are slowly working through their valuation problems with mortgage backed securities. Phase I was to determine what they actually held and the details of what those holdings contained. This phase, Phase II, is now valuing the holdings and it's "hot potato" time...i.e. trying to get rid of a lot of the mortgage stuff they've determined has about the quality of junk bonds.

As the extent of Bear holdings and problems spread on the street, other banks closed their doors to Bear (some undetermined European Bank and Goldman Sachs, according to rumors). The refusal of these banks, most notably Goldman, threatened to throw Bear into default and bankrupt the company. Enter the Fed and JPM&Chase. As I understand it, the Fed will loan Bear sufficient funds to meet its obligations, but through JPM&Chase. That's curious. Two possibilities: 1) JPM&Chase is about to take over Bear, or 2) the situation at Bear is so desperate that the Fed is expecting them to go under, regardless of their support, and required a third party to essentially step in and take over managing Bear. As part of the deal, JPM&Chase will NOT be held liable for Bears' losses, which - if any - will be presumably be borne by the Fed. In other words, it is a "bail-out."

All of this is consistent with the Fed Chairman's testimony before Congress about two weeks ago, wherein he stated that he thought it possible that some banks would fail before the subprime crisis was over. Of course, big question is: Who else?

I suspect that as of this moment no one can answer this question. However, as the valuations of mortgage backed securties continues, expect further losses and the strong possibility of additional failures. Bank write-offs to date apparently were based on sketchy information regarding their own holdings. If they were overly conservative...then one might expect a reasonably quick "recovery" (and we continue building the house of cards, if my theory of a generally overvalued economy is correct). If they initially underestimated their losses...there is more to come. Unless we are willing to tackle what I believe is the real underlying problem (the pace of globalization), either way we lose.

All in all, having lacked necessary oversight all along, valuation is a tough cookie, because ultimately those valuations depend on what is going on at the other end of the problem - the homeowners who are facing default. First tier lenders and the government are supposedly working through this end of the problem. To date, about 120,000 home owners have done "something" to work a deal to avoid foreclosure. By the end of this year, the government expects this number to rise to 300,000. Ah...300,000 out of the 2 million that may go into default as their ARMs roll-over.

Sound like the government's response to Katrina? Well, there is a significant difference, because it won't be individual home-owners pressuring the government for a work-out; it will be Wall Street.

Bush addressed the Economic Club of NYC this morning. Nothing really new...still in denial. Tax cuts, free trade, etc. No recession, just a small down-turn. Economy is actually great. Clearly, in his mind, society is a sub-set of the economy and not the reverse. His answer to the lost of American jobs? More training. If he considered the reverse, the economy as a sub-set of society, then the economy would reflect the capabilities of the work force. Training is certainly part of the solution to job losses overseas, but the shift has to be over a greater time span, and quite possibily is generational. Current policy is "we're totally changing our economy and you (the former textile or steel or automotive worker) better keep up with it or you're screwed and it will be your fault." And, of course, once the present crisis rolls out add to the un-or underemployed, textile, steel and automotive workers, a sizable army of "financial service workers," who have probably already re-trained once or twice. The alternatives are reasonable government policies, which protect American workers (and the economy) as we move through this global realignment, but such clashes with Bush economic philosophy.

He did mention, in passing, that the government (including the Fed) was moving to increase "oversight" of the mortgage business, although he went on to link the "oversight" with the necessity to ensure that borrowers could still find loans in the housing market. Right. Sort of like curing your headache by banging your head against the wall harder.

Two Administrations, over sixteen years, have refused to stand up and tell the American voters the truth, while hollowing out the American economy, with cheap, feel-good credit. But, more on all of that with a return to the central theme - The New Economy.