Don’t bet against one more Bear Stearns performance

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All market participants must still confront the reality of near total market failure across the debt and money markets, an inability to sell even quality assets for cash or to borrow against them and a complete loss of faith between financial institutions. More public money is surely coming, but how can it repair this?

The disappearance of Bear Stearns over a weekend (well, two weekends) is an emotionally charged piece of theatre. The moment of high drama was all the more loaded symbolically for all its well-rehearsed movements and staging being so reassuringly familiar.

Here we have the frantic bankers, struggling to shore up their once sturdy institution as the run gathers momentum. The wealthy private sector executives are brought to heel by truly powerful government leaders, half-glimpsed dispensing their judgments from just off stage and grappling with a greater burden: not merely the fate of little Bear Stearns but the survival of the very system itself lies in their hands.

There are the moments when no deal seems possible, then the breakthrough when JPMorgan commits itself to stand behind the broken firm, after less than two days’ due diligence and with no material adverse change clause to fall back on if it turns out to have bought a swamp-full of toxic waste, but only if the Fed guarantees to finance $30 billion of questionable collateral.

The tired participants call for deliveries of Chinese food, planes start landing with other bank CEOs recalled to the US from around the world to witness the final sacrifice: Bear Stearns is dragged to the edge of the pit and cast in. It’s to be hoped the outraged gods are appeased.

Thus the US Treasury and the Federal Reserve fold 85 years of one firm’s history into a narrative of catastrophe and redemption that they expect the rest of the market meekly to fall in with. Bear’s sudden end, the loss to shareholders and employees may be truly awful, but, as with Gloucester’s eyes being put out at the end of Act III, the audience should know that, while there may be more suffering ahead for King Lear, it won’t get more horrible than this. We have reached the cathartic moment and the path to eventual recovery lies, faintly outlined, before us.

And do you know, says JPMorgan, when we looked through Bear’s books, the quality of its assets and rigour of its marks weren’t that much out of line with our own. Who’da thunk it?

It’s all just a bit too pat.

The affair certainly reveals the powerful interventionist instincts of the US body politic – its utter determination to preserve the system at the cost of any weak link, and hang the primacy of shareholder value. It nationalized the risk and privatized the profit. And this is truly reassuring.

In the aftermath, even as the details were renegotiated, thus chipping away a little at the Fed and Treasury’s veneer of authority, bank and broker CDS spreads fell back from shocking highs in early March, as did the two-year swap spread.

Lehman was marched to the edge of the pit but not cast in. So, are we truly past the most dangerous moment? Perhaps not.

The truth is, Bear Stearns simply does not matter. Its demise is no catharsis. No one will miss a mid-sized firm that was really good at trading mortgage-backed securities. The story of how JPMorgan acquired its prime brokerage and securitization platforms – yesterday’s businesses – is of no significance. Prevention of a disorderly collapse, and the removal of $30 billion of assets from immediate distressed sale, might have headed off a crisis. But all market participants must still confront the reality of near total market failure across the debt and money markets, an inability to sell even quality assets for cash or to borrow against them and a complete loss of faith between financial institutions.

More public money is surely coming, but how can it repair this? Creating a false market in the instruments cascading out of over-leveraged credit structures and portfolios might even do more harm than good. The crisis will only be past when buyers are convinced that deleveraging and write-downs have produced value in functioning markets where it can be realized: and that means bought and sold.

The truly encouraging news in March was that Lehman, amid managing down its mortgage exposures, has also opportunistically been buying certain beaten-down assets and finding Alt-A mortgages easier to value. And the number of US house sales is rising, even as values plummet.

To head off severe economic downturn, the US has slashed interest rates and debased the currency. It will now also spend heavily. But any project to use public money to sustain damaged markets must be very carefully limited. It’s good that management of the damaged Bear Stearns portfolio has been outsourced to BlackRock. Circuit breakers are fine. But preventing damage to the system must not be confused with preventing severe losses for specific institutions or investors. Fragile and dangerous though they have proved themselves, markets must function again before we are through this.

Of course, that raises the prospect of at least one more Bear Stearns weekend before we’re done. At least we all know the script.