March 24, 2008

Bear Stearns Rant

Today I woke up to the news that JP Morgan is going to re-evaluate and offer a higher number to Bear Stearns for the buyout.  If people remember right, it was last week that the Fed organized a buyout of Bear Stearns in the face of a massive liquidity problem.  The Fed's reasoning at the time was that Bear, using a series of counter party transactions (which is a fancy way of saying Bear would take debt, re-package it and sell it, to offset their risk), simply created too much overall exposure to the market as a whole.  It was too difficult to find out all of the counter parties and or the counter parties were too large themselves and if things started to go sideways the unraveling was going to be disastrous having massive ramifications throughout the entire market.  

So, the Fed stepped in and organized a non-bankruptcy bankruptcy for Bear by having JP Morgan buy them and the Fed backing the sale with "Fed dollars" (in case anyone was wondering that would be tax payer dollars or printing press dollars thus eroding the value of the dollar.) At the time I read this I was annoyed at the Fed stepping in but after listening to some of the reasons and considering the counter party situation finally concluded that, though I disagree with the Fed bailout, possibly in this situation it was merited.  

Then I read the news this morning.  Because of shareholders at Bear Stearns, JP Morgan is considering offering $10 a share instead of the $2 a share initially agreed upon.  The part that angers me is the following article that explains the Fed's approval of this.  Basically JP Morgan is putting up 1 Billion dollars and the Fed is putting up the other 29 billion dollars.  That is leverage of 29:1, at the fed rate of around 2.25 percent. That is ridiculous.  I'm okay with the increase in sales price from the standpoint of the shareholders of Bear that were and are still getting totally screwed, but it is crazy that we are using Fed money or Taxpayer money to pull off this bailout.  How many other banks and investment firms out there were overly greedy and are in the same boat?  Are we going to bail them all out?  If so what happened to letting the market function?  If we are going to bail out these large corporations what about homeowners that got overextended why not bail them out?  

Aside from the slippery slope argument, the government's not letting the market function "naturally" is what caused the Great Depression.  The Fed argues that if they don't do this it could force us into a "depression" however, if they do this are they just kidding themselves? Since they can't possibly bail out all of those banks and investment firms that are going to have problems without completely destroying the economy, dollar, and equities market (by artificially inflating P/E ratios), are they saving us from a depression or pushing us closer to a massive depression?  Time will tell.  

Needless to say I'm not bullish on the stock market right now, and for your average investor, I would stay in cash (realize, of course, with inflation around 4% and money markets around 2.5% you are losing 1.5% on your cash).  If you can't stay in cash for whatever reason use the sound strategy of slowly averaging into positions (buying a little each month), it wouldn't hurt to possibly buy some put options for those that already are heavily invested in stocks.  For an explanation on put options I will post later.

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