More on Bear Stearns - Step 9 of the financial meltdown

nouriel roubini's 9th step of the financial meltdown...

Step 9 of the Financial Meltdown: "one or two large and systemically important broker dealers" will "go belly up"

more roubini...

Let us be clear: given its massive exposure to toxic MBS and ABS product Bear Stearns is insolvent; the decision by the NY Fed to try to bail out Bear Stearns would make sense if this firm was only illiquid; the trouble that it is insolvent and thus such attempted bailout is altogether inappropriate. It is true that Bear is a large broker dealer; but its systemic importance is much smaller than that of much larger institutions. The world and financial market can survive if Bear disappears.

So the only possible justification for such Fed action is to engineer an orderly rather than a disorderly shutdown of this institution. But unfortunately the Fed is behaving as if Bear Stearns is illiquid but solvent. That is delusional and the official sector support of an otherwise insolvent institution will end up - like many other recent Fed actions - being paid for by the US tax-payer.

As discussed months ago in this column non-banks institutions don't have access - based on the Federal Reserve Act - to the lender of last resort support of the Fed unless a very special and unusual procedure and vote is taken. So for the first time in decades - possibly since the Great Depression - the Fed had to rely on this exceptional rule to bail out a non-bank financial institution. So what is next? Bailing out hedge funds, bailing out money market funds, bailing out SIVs? When is enough enough? This when the Fed has already committed this week to swap 60% ($ 400 bn) of its balance sheet of Treasuries for mortgage backed securities of dubious quality and value.

And Bear is only the first broker dealer to go belly up.

and now...?

JPMorgan Chase & Co is close to rescuing the fifth-largest U.S. investment bank, Bear Stearns Cos Inc, a person familiar with the matter said on Sunday, in a deal that could be announced in the next few hours.

The Wall Street Journal said on Sunday that Bear Stearns could sell itself for around $2.2 billion, or less than $20 a share.

The low sale price, equal to about two-thirds the company's $30.85 closing share price on Friday, signals just how dire the situation is for the 85-year-old investment bank.

The deal with JPMorgan Chase has not been signed yet, said the person Reuters spoke with on condition of anonymity.

Bear Stearns' cash reserves were drained by fleeing customers on Thursday, and on Friday the bank secured emergency funding from the Federal Reserve, extended through JPMorgan Chase.

The Fed is widely seen as having provided the financing to prevent Bear Stearns from toppling, and potentially bringing other banks down with it.

things are getting pretty wild...

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