Fedization

Tuesday, March 25, 2008

Ladies and gentleman, welcome to a new economic term. As the privately owned Federal Reserve New York starts out on a banking shopping spree, the new twist in the latest systemic crisis of the financial sector shall be called Fedization in contrast to the old-fashioned nationalization that stood at the end of past banking crises.
The Federal Reserve has now entered the casino in a sacrilegous way, by taking (in)direct stakes. Forget level playing fields, some investment banks will be more equal than others, withstanding all contrasting official statements to come.
What's next on the shopping list? General Motors, Starbucks coffeee served by the Fed or more funny paper for a share in Fannie Mae and Freddie Mac?
On Monday the Fed NY announced that it would form a limited liability corporation that will provide another $29 billion in financing for JP Morgan's purchase of Bear Stearns. This LLC will receive $30 billion in assets from JPM as collateral for its loan, financed at the discount rate of 2.5%.
The statement says,
At the closing of the merger, the Federal Reserve Bank of New York ("New York Fed") will provide term financing to facilitate JPMorgan Chase & Co.'s acquisition of The Bear Stearns Companies Inc. This action is being taken by the Federal Reserve, with the support of the Treasury Department, to bolster market liquidity and promote orderly market functioning.
The New York Fed will take, through a limited liability company formed for this purpose, control of a portfolio of assets valued at $30 billion as of March 14, 2008. The assets will be pledged as security for $29 billion in term financing from the New York Fed at its primary credit rate.
JPMorgan Chase will bear the first $1 billion of any losses associated with the portfolio and any realized gains will accrue to the New York Fed. BlackRock Financial Management, Inc. will manage the portfolio under guidelines established by the New York Fed designed to minimize disruption to financial markets and maximize recovery value.

This stinks as does the rest of this multi-billion deal where I am still looking for the actual cash involved. So far I can only see several layers of debt. Why is this portfolio valued at prices of April 14? What happened to realtime data? How much is this portfolio worth today?
According to the WSJ, taking it from the NYT, JPM will now exchange 0.21753 shares for every Bear share, effectively quintupling the original offer of 0.05473 shares. No cash here.
The offer was also sweetened with an issue of 95 million new Bear shares JPM will buy until April 8, giving it a 39.5% stake in outstanding shares. No mentioning of cash here either.
The WSJ has the full text of the "merger" agreement here. According to it JPM will enact an exception of the NYSE's Shareholder Approval Policy which provides an exception in cases where the delay involved in securing shareholder approval for the issuance would seriously jeopardize the financial viability of the listed company.
While this may be good news to Bear debt holders this action by the Fed NY raises the question whether Fedization will be a new precursor in the century-old banking cycle that provides dividends for shareholders in good times and a nationalization of losses at the end of ever monetary expansion process.
The Fed as a step-in to keep the mountains of pretensions markets are helped with since August 2007.
Pretensions such as: The Fed pretends the collateral has a value and markets pretend the freshly digitized billions of credit are money.
I also fail to understand what it means that the Fed will absorb the first billion of losses on the collateralized portfolio. Is this an effort to build trust that the Fed actually sees value in this portfolio?
Anyhow, I am confident that the new twist in cleaning up the mess will not be sen the last time now that the Fed NY has opened the floodgates, with the official encouragement of the US Treasury. There are many more investment banks under the waterline that cannot be nationalized as the state certainly has no function in taking part what is effectively institutionalized gambling.
But the question of moral hazard has probably never been of higher importance than nowadays as Nanny Benny works overtime to help bankers stay in their mansions.
Fedization is here to stay - and may probably grow much larger before this year is over.

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