In an unusual move, the Federal Reserve took action late Sunday night to intervene in the Bear Stearns (NYSE: BSC) situation to stave off a possible crisis in the financial markets. After a weekend of meetings, the Fed, which had already declared on Friday that it would largely assume the risks in a proposed purchase of Bear Stearns by fellow investment bank JP Morgan-Chase (NYSE: JPM), took a greater role in this latest action. The Fed, in effect, will not only back the acquisition of Bear Stearns by JP Morgan, but will make available short-terms loans for other investment banks in an attempt to keep the financial markets and the credit markets in particular, liquid.
The Fed decided to increase its involvement over the weekend in the Bear Stearns situation when it appeared that the Wall Street firm was headed for almost certain bankruptcy. Only last week, Bear Stearns had vigorously denied rumors that it had a liquidity crisis. By Friday morning, however, it appeared that many of the firm’s large clients, which include hedge funds, were reluctant to do business with Bear Stearns. This crisis in confidence, along with the investment bank’s highly leveraged positions with its complex assets, made for a precarious position for Bear Stearns. So the Fed stepped in.
In addition, the Fed will make short-term money more available to the other investment banks such as Lehman Brothers (NYSE: LEH), Merrill-Lynch (NYSE: MER), and Goldman Sachs (NYSE: GS). The Fed has also lowered the discount rate (the short-term bank lending rate) from 3.5% to 3.25%. This rapid Fed action is all ahead of and in addition to its regular F.O.M.C. meeting on Tuesday, March 18, at which the Fed is expected to further lower the Fed Funds rate (the consumer lending rate), which stands at 3%, by as much as another 1% or more.
Bear Stearns stock, which traded as high as $159 a year ago, closed at $50 a share on Thursday, $30 on Friday, plunged to $4 or less a share in trading on Monday and closed at $4.81. The JP Morgan-Chase offer to buy Bear Stearns for a paltry $2 a share, or $236 million, is a fraction of Bear Stearns’ recent market cap, yet it is difficult to determine what the book value of the firm would be in this near-liquidation mode. Some observers have suggested that there is value in the firm’s highly leveraged assets, while others have suggested that much of what Bear Stearns holds is illiquid and so complicated that it would be difficult to evaluate the company’s worth.
This run on an investment bank, which prompted an extraordinary move by the U.S. central bank, highlights the continuing problem of the credit crisis which has spread its tentacles into nearly every aspect of the financial markets as well as the economy. What further damage there will be to the financial markets is open to speculation now, as is the further threat to the economy. The action of the Fed is an attempt not only to resolve the immediate crisis on Wall Street, but to provide liquidity with orderly markets going forward, and by implication, to arrest any cascading crisis in the financial markets from contaminating or further damaging the economy. Monday’s stock markets reacted with a wide-ranging response, as the markets opened down, then oscillated through negative and positive territory, final closing with the Dow up 21.16 at 11,972.25. More volatility is expected to follow as the Bear Stearns aftermath plays out in the markets.
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