August 4, 2007 — the beginning of the end: the Bear Stearns conference call

Original here. One of the features of the Fed’s and the US government’s management of the capital markets over the last several decades has been their acting at appropriate times to prevent or swiftly correct panics or other major market dislocations. Many financial “crises” have come and gone over the last twenty years with few lingering deleterious effects.

The response to the Stock Market crash of 1987 (in which the DJIA shed 22% of its value in one day), the Mexico bailout of 1995, the bailout of Long Term Capital Management in 1998, the handling of the NASDAQ crash of 2000, and the mini-bailout of the airlines in the aftermath of 9-11, are arguably all good examples of the government doing its job effectively. The reason is that far worse could have happened in each case than actually occurred. In that sense, these are all dogs that did not bark.

On Friday, in the aftermath of S&P changing its rating of the debt of Bear Stearns from stable to negative because of its problems in the sub-prime mortgage market, executives at Bear Stearns responded with a conference call. In the conference call the CFO stated that conditions in the fixed-income markets are the worst since 1985, a period encompassing all the crises cited at the top of this piece. History will tell if the comments of Sam Molinaro prove to be memorable or not:
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Without question the stock market took this remark seriously. The call started at 2pm. As the WSJ put it: “the somber comments exacerbated the market drop, with Bear stock and the Dow industrials — which had been off about 50 points before the conference call — falling further…The index ended the session down 281.42 points, or more than 2%, at 13181.91″:

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As the WSJ noted, the securities firm is going to some great lengths to fix things:

Bear, which employs 13,566 people, has seen its stock-market value shrink by more than one-third during 2007, bringing its total market value to about $12.5 billion…During morning trading, Bear shares fell nearly 8% to $106.55, a new 12-month low. At that price, Bear stock was trading below 1.2 times its book value…The cost of credit protection — or the amount investors bet against the chances that a company will default on its credit obligations — for Bear is more than seven times higher than what it was at the start of the year…

Bear said it reduced its short-term unsecured debt known as commercial paper to $11.5 billion from $23 billion in January. Treasurer Robert Upton said the company has unused committed secured bank lines that are “of over $11.2 billion, $4 billion of which is available to be drawn on an unsecured basis.” Over the past eight months, it has raised more than $11 billion of cash. Mr. Upton also said the firm has “unencumbered collateral” — or assets not underpinning loans — exceeding $18 billion…

The big securities firm also plans to oust Warren Spector, Bear’s powerful chief of stock and bond trading and one of the firm’s two presidents…

The market moves yesterday highlight just how jittery investors have become about the welfare of Wall Street’s biggest firms, which depend on a combination of goodwill and short-term financing to stay in business. “Everybody’s waiting for the second, third and twentieth shoe to drop,” said Mike Vogelzang, president of the money-management firm Boston Advisors.

So some things look dicey on Wall Street. Is that a big deal? We don’t know. As one wag put it, the stock market has predicted nine of the last five recessions. However, it is fair to note that the fear is palpable today. And it might be useful to remember that our greatest economic upheavals have not been caused by market crashes, but by the credit crunches that follow fear and panic, and it is a credit crunch that is the crux of today’s fears. Cramer, commenting on the conference call and Sam Molinaro’s remarks:

What we were hoping to hear him say, and we sure didn’t, was that Bear has traded in all kinds of markets, and this one will be no different, and when the time is right, it will buy back stock — or that it had started — and that the idea of liquidity issues is so ridiculous as to not even be worth mentioning. Nope. We got the opposite…

I think it is important that someone state in unequivocal terms that the Fed needs to act to avert a crisis. Is it Armageddon? No, if the Fed acts. But yes, if you are trying to keep your home and the Fed doesn’t act, I am sure there are plenty of people out there who aren’t trying to buy a home and are paying their mortgage and are sitting there thinking what the heck is this all about. But the banks can’t get the money they need, the brokers don’t have the liquidity they need, and the homebuyers and recent homebuyers who used debt are really hurting.

We don’t know that there is anything concrete that the Fed can do in this situation, but it would appear prudent for the Fed and chairman Ben Bernanke to acknowledge that there is in fact a problem, and that the Fed will act to provide all necessary liquidity to the banking system and financial markets. We recall his rosy comments earlier this year, which contrasted with a prediction of a 33% chance of recession advanced by Alan Greenspan at the same time. This situation is in some ways his first major challenge as Fed Chairman. It would be good if he does not make memorable the words of Bear Stearns CFO Sam Molinaro.

UPDATE: Half a year after this, Bear, which had traded at $172 a share in 2007, was sold to JP Morgan Chase in a Fed bailout for $10 a share. This was followed shortly thereafter by the government’s disastrous decision not to bail out Lehman Brothers, but let it fail.

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