Even posing the question might put me in tinfoil-hat territory, but I'm going to pose it anyway: Is all the sturm and drang this morning over J.P. Morgan upping its offer for Bear Stearns (Why was the original offer so low? Why were Bear shareholders getting such a raw deal? How long can Cramer resort to semantics to justify his rotten call on Bear?) a clever way to distract the lumpeninvestoriat from the very real and troubling questions surrounding the bailout?
We've already talked about some of those questions — the Fed adding the bailout of investment banks to its existing burden of bailing out commercial banks, to say nothing of the Fed putting up $30 billion to make it all worth J.P. Morgan's trouble.
It was one thing for Hank Paulson to pooh-pooh the moral hazard question last weekend even as terms of the bailout were being negotiated. But now the power elite has come up with a more sophisticated explanation: Anyone who thinks Bear Stearns should have just taken its lumps doesn't realize that letting the free market do its thing would have brought down the entire global financial system. We see that in Ambrose Evans-Pritchard's coverage this past weekend in the London Telegraph.
We may never know for sure whether the Federal Reserve's
rescue of Bear Stearns averted a seizure of the $516 trillion
derivatives system, the ultimate Chernobyl for global finance.
"If the Fed had not stepped in, we would have had pandemonium," said James Melcher, president of the New York hedge fund Balestra Capital.
was the risk of a total meltdown at the beginning of last week. I don't
think most people have any idea how bad this chain could have been, and
I am still not sure the Fed can maintain the solvency of the US banking system"…
Bear Stearns had total positions of $13.4 trillion. This is greater than the US
national income, or equal to a quarter of world GDP – at least in
"notional" terms. . . This heady edifice of new-fangled instruments was
built on an asset base of $80bn at best.
the other side of these contracts are banks, brokers, and hedge funds,
linked in destiny by a nexus of interlocking claims. This is
counterparty spaghetti. To make matters worse, Lehman Brothers, UBS,
and Citigroup were all wobbling on the back foot as the hurricane hit.
years ago the Fed would have let Bear Stearns go bust," said Willem
Sels, a credit specialist at Dresdner Kleinwort. "Now it is too
interlinked to fail.". . .
Hear, hear, says an Economist editorial.
Rescuing Bear Stearns and its kind from their own folly may strike many
people as overly charitable. For years Wall Street minted billions
without showing much compassion. Yet the Fed put $30 billion of public
money at risk for the best reason of all: the public interest. Bear is
a counterparty to some $10 trillion of over-the-counter swaps. With the
broker's collapse, the fear that these and other contracts would no
longer be honoured would have infected the world's derivatives markets.
Imagine those doubts raging in all the securities Bear traded and from
there spreading across the financial system; then imagine what would
happen to the economy in the financial nuclear winter that would
follow. Bear Stearns may not have been too big to fail, but it was too
So there you have it the next time someone gets into trouble: They must be bailed out and the dollar must be further devalued because if they're not, we get "nuclear winter" or "Chernobyl" — pick your favorite atomic metaphor.
Left unaddressed is when do we reach a point of no return — when there've been so many efforts to forestall a nuclear winter and keep hundreds of trillions in derivatives from becoming worthless… that the dollar in which many of those derivatives are valued itself becomes worthless?
Oh, well. If nothing else, this sort of talk gives me more confidence taking the inflationary side of the will-the-collapse-be-inflationary-or-deflationary argument.