Committee To Save The World

Bailout OR Ripoff!?!; PART ONE:
The New "Committee To Save The World"

By Felix Salmon | 16 March 2008

Ben Bernanke hasn't caught very many lucky breaks of late, but the fact that Bear Stearns hit its liquidity crunch and got downgraded by all three ratings agencies on a Friday is probably one of them. The downgrades weren't welcome, of course, but they did inject a sense of urgency into proceedings: a clearing investment bank can't function with a BBB rating.

[ Normxxx Here:  The fact that all this happened 'simultaneously' and on a Friday was no coincidence and certainly no "accident"!  ]

Over the course of the weekend, a new Committee to Save the World was convened. And so, before the markets reopen on Monday, Ben Bernanke, Tim Geithner, Hank Paulson, and Jamie Dimon can announce, with no little sense of relief, that Bear Stearns is being bought by JP Morgan.

That news will likely send stocks up— with the exception of BSC, of course, which is being acquired for the bargain-basement price of $2 a share, despite the protestations of Bear's management that the bank's book value is still over $80.

This is a much better outcome than Bear being bought by Chris Flowers: if that had happened, there would have been question marks over his ability to withstand major further write-downs. With JP Morgan, there's no such question: JP Morgan Chase is enormous enough, and was fortunate enough to avoid the worst of the mortgage meltdown, that no one's going to worry about it failing.

The mooted price for Bear Stearns— roughly zero, despite the fact that Bear's headquarters alone is worth over $1 billion— is low enough that it gives Dimon a lot of room for maneuver. He can keep Bear as a going concern, take what bits he likes, and then close or sell off the bits he doesn't want over time, as the chaos dissipates. So my feeling is that there won't be mass layoffs in the short term, although Bear's top earners might well walk out the door on their own if they feel that this year's bonuses are likely to be nugatory.

But the price is also so low that it implies a huge amount of risk in the deal. And so the next question arises: if there's that much risk in Bear Stearns, how much risk is there in Lehman Brothers? Lehman's shares fell by almost 15% on Friday, and are now within shouting distance of falling below book value. Merrill Lynch, Morgan Stanley, and Goldman Sachs, by contrast, seem safe for the time being.

Still, I can't remember a time when investment banking, as an industry, was in as perilous a position as it is now. The LTCM crisis of 1998 was bad, but this is worse. Brad DeLong, in an excellent blog post, explains that the crisis has blindsided the markets precisely because no one thought that the investment banks were as bad at risk management as they in fact turned out to be. Now, no one trusts those banks to be good at risk management any more. And the existence of trust is a necessary precondition for efficient markets.

The other must-read post of the weekend comes from Steve Waldman, who would like to see a return to the days when trust was a central part of the banking system: the days when JP Morgan himself told Congress that "a man I do not trust could not get money from me on all the bonds in Christendom". "We shouldn't go back to the world as it was at the turn of the century," says Waldman,

But I do think that it's an interesting technical question, going forward, whether we couldn't set things up so that the criteria by which investors decide where to put their money map more closely to what we would recognize as trustworthiness or character.

There are two levels of trust which matter here. One is trust in financial institutions individually: fear of Bear Stearns suffering from a liquidity crisis was self-fulfilling, and the same could happen to other banks too. But the other is trust in the financial system more generally, and that's where the Fed's bailout comes in. The TED spread is still unhealthily wide, indicating that there's a huge amount of nervousness surrounding the health of the banking system as a whole, and it's the Fed's job to reassure the markets that the system will survive. One way of doing that is to make sure that liquidity crises like the one which hit Bear Stearns are dealt with in some semblance of an orderly and effective manner.

So it was very weird to read this, from Gretchen Morgenson, on Sunday:

Regulators must do whatever they can to keep the markets open and operating, and much of that relies upon the confidence of investors. But by offering to backstop firms like Bear, who were the very architects of their own— and the market's— current problems, overseers like the Fed undermine a little bit more of that confidence.

I think this is exactly wrong. Morgenson is right that the confidence of investors is needed if the markets are to remain open and operating. But letting Bear fail and default would boost the confidence of absolutely no one. Settlement risk alone would be reason enough for the Fed to provide support, even if the general mood of the market weren't so nervous that a major bank failure would risk a broad-based panic.

What the Fed's doing here, with the help of Jamie Dimon, isn't rescuing Bear Stearns, so much as trying to provide some kind of safety net for the financial system more generally. It's an open question whether or not the Fed has the ability to do that. But it surely has to try.

Committee To Save The World Plans 10th Reunion

By Caroline Baum | 31 May 2008

May 1 (Bloomberg)— More than nine years ago, the faces of Alan Greenspan, Robert Rubin and Lawrence Summers graced the cover of Time Magazine as "The Committee to Save the World." At the time, America was riding high. Growth was strong, inflation and unemployment were low, the stock market was soaring. The near-collapse of hedge fund Long-Term Capital Management in the fall of 1998 turned out to be a blip on the radar screen, while the prescribed cure— interest-rate cuts— fueled the final leg of the bubble in Internet and technology stocks.

Asia experienced a financial and economic crisis in 1997; Russia in 1998. With Rubin and Summers at the helm at the U.S. Treasury and Greenspan's hand on the tiller at the Federal Reserve, the U.S. sailed through the crises unscathed. "The men don't get all the credit for the boom— they're the first to say all they did was let the markets work— but on both Wall Street and Pennsylvania Avenue, they get the bulk of it," Joshua Cooper Ramo wrote in the Feb. 15, 1999, Time story.

The boom, or rather the bubble, went bust in 2000. Things got better, we had another bubble, this time in residential real estate, and it, too, met its maker. So where is the Committee to Save the World today? None of the three men, whom Ramo called a "free-market Politburo on economic matters," is doing much saving, except when it comes to their respective reputations. None is employed by the government, a prerequisite for savior status.

Chairman of What?

Greenspan's legacy is in tatters as the housing bubble that inflated on his watch went "pop" in a shot heard 'round the world. Summers was booted from the Harvard University president's office in early 2006 for politically incorrect comments about women in science, a badge of honor in my book. And Rubin, chairman of Citigroup Inc.'s executive committee, still has some questions to answer, even after trying to absolve himself of blame in the bank's fall from grace.

Such as, what were you doing in that office next to Chuck Prince, the former CEO, while Citi was burning? Citigroup has reported more than $40 billion in losses and writedowns since November. "It's a made-up role," says Jim Bianco, president of Bianco Research in Chicago. "Other Wall Street firms don't have a chairman of the executive committee, a wise man paid to stroke his chin and prevent this from happening."

An April 27 New York Times story pointed out that Rubin had no "specific business responsibilities and was free to use his perch to sound off on public policy." For this— he had "responsibility without accountability," according to an unnamed banker quoted in the Times' story— he was paid more than $10 million a year.

Alumni Event

As the Committee prepares to celebrate its 10th anniversary in February, it seemed like a good time to reflect on the significance of the 1999 Time cover. So I called Paul McCrae Montgomery, creator of the Magazine Cover indicator, to get his view. First, some background on the indicator. Montgomery studied magazine covers going back to the 1920s and found that by the time an investment idea makes the front of a general-interest weekly, such as Time, it has probably attained maximum saturation. There is no one left to buy, or sell. A Time cover tends to give a boost to the market or financial phenomenon it's touting for a month or so after it appears. One year later, fading the cover has proved to be a reliable money-maker 80 percent of the time, according to Montgomery.

Three's A Crowd

So what does he think of the Committee's fall from grace in light of its former savior status? Montgomery confessed he hadn't given it much thought or done much statistical analysis because triumvirate covers are rare. "They don't build statues to committees," he said. Within minutes, he had e-mailed me an old issue of his weekly commentary on a Dec. 19, 1993, Time cover with another less-famous threesome, "the committee to save the auto industry."

There on the cover of Time, striking their best Mount Rushmore pose, are Chrysler's Bob Eaton, Ford's Alex Trotman and General Motors's Jack Smith, all former CEOs, next to the headline, "The Big Three: How Detroit Is Shifting Into High Gear." GM stock peaked about a month later, losing almost half its value by the end of 1994. Ford and Chrysler tumbled as well. That's pretty much in line with the predicted performance of a Time cover. I was still searching for the meaning of the World-Saving Committee cover.

Of Rising Tides

"While I do not have any data on it, your instincts may be correct on the possible added puissance of tripartite covers," Montgomery wrote in an e-mail. "One person on the cover may, on occasion, reflect unique, sustainable genius. Three persons on the cover is almost certainly the result of 'a rising tide that has lifted all such boats'."

We're at low tide now. The beach is strewn with flotsam. The Committee to Save the World, last seen paddling furiously against the tide, has been washed out to sea.

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Normxxx    
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