The papers lead with the stock market going manic yesterday on bolstered confidence in Wall Street banks and another big rate cut by the Federal Reserve. The Dow Jones Industrial Average shot up more than 420 points (3.5 percent), the biggest point gain in more than five years and more evidence of the serious volatility that continues to roil markets.
Oddly enough, it was the second Tuesday in a row with massive gains. On the 11th, the Dow soared 417 points on a previous Fed cash drop. Forgot about that already, huh? The Wall Street Journal on C1 says last Tuesday’s gain was actually larger in percentage terms than yesterday’s and asks in its sub-headline if it’s a “One-Day Wonder.”
Banks and investment banks led the rally, with Lehman Brothers skyrocketing 46 percent and more than recouping its losses in the last week. Bloomberg says it was the biggest day for financial stocks since 2000.
When bad news is good
What sparked the buying? Earnings reports at Lehman and Goldman Sachs showed profits fell 57 percent and 53 percent respectively. That’s normally a very bad thing but not in this market, which feared much worse. The WSJ calls the rally a “measure of how bad things have gotten lately” and says investors exhaled because they found no signs of Bear Stearns-style cash problems in either firm’s quarterly report. Each company had about $2 billion in asset write-downs in the quarter, but that raises questions about whether they’re valuing the assets correctly according to so-called mark-to-market rules.
The San Francisco Chronicle quotes a banking analyst saying that Lehman’s conference call “was perhaps the best conference call in a couple of decades.” Having sat through a few earnings calls ourselves we can attest that’s not saying much, but Lehman appears to have laid out carefully its financial situation in as transparent a manner as possible.
Quote of the Day goes to Bloomberg:
“Getting some reinforcement that the wheels weren’t falling off of all the brokers was a great thing, because everyone was fixated on the troubles at Bear,” said E. William Stone, who oversees $77 billion as chief investment strategist at PNC Wealth Management in Philadelphia. “It had gotten so negative that people were thinking the entire financial system might be collapsing, so anything short of that was seen as a positive.”
Fed battle plan
That’s remarkable if true, since the Fed dropped its benchmark federal-funds rate by 0.75 percentage points to 2.25 percent and said more cuts are on the way. It was only the second time since 1994 the Fed has delivered such a big decrease, the WSJ says on page one.
The Los Angeles Times claims that the Fed move is intended to get investors out of CDs and money-market accounts and back into stocks. That’s a pretty shaky thesis, though the paper notes correctly (and obviously) that the move is intended to entice lenders to lend. Duh.
The Journal lists the massive government forces arraying for battle against the financial crisis:
The Fed’s actions are among several aggressive steps throughout the federal government that are coming to a head this week and could prove critical in combating the crisis. Today the regulator of Fannie Mae and Freddie Mac, which provide the bulk of funding for home mortgages, is to announce an easing of their capital requirements and the companies are to pledge to raise more capital, people familiar with the matter said. Those steps should enable them to back more mortgages.
Meanwhile, the Bush Administration which has so far resisted using large amounts of public money to save borrowers and lenders from bad loans, may be ready to compromise with Democrats on a more activist approach to the housing crisis. The Fed is “running out of pages in its playbook to address the growing crisis of credit and confidence,” Senate Banking Committee Chairman Chris Dodd, who has proposed the Federal Housing Administration insure up to $400 billion in troubled mortgages, said yesterday. Now the Bush administration should be “equally aggressive.”
At the same time, all the papers note that the Fed indicated that inflation will now weigh more heavily on its future decisions.
Will JP Morgan get its Bear?
The Bear just won’t go down without a fight. Investors pumped up Bear Stearns stock to nearly $6 a share yesterday—triple what JP Morgan has agreed to pay. That’s what they call one helluva spread on the arbitrage desks on Wall Street, which bet on or against the likelihood of a merger going through.
The so-called spread is the difference between what the company has been sold for and what its shares actually trade for before the deal is completed. Typically, stocks of companies that agree to be sold trade below the sale price. The closer to the actual price, the more likely investors think the deal will actually go through at the price agreed upon. If they trade above the target price, markets believe another bid is likely.
The WSJ’s good Heard on the Street today says markets are implying that JP Morgan will have to cough up more cash to take over Bear Stearns or that there’s another Bear hunter sniffing around out there.
But the Journal says the unusual pricing may have more to do with financial machinations:
Part of yesterday’s rise was attributed to Bear Stearns’s bondholders, who are eager to see the deal get done and avoid a bankruptcy. Bear Stearns’s debt issues will be converted into J.P. Morgan bonds if the deal is approved, and these creditors are buying shares so they can vote on a deal. Other investors are shorting Bear bonds and credit-default swaps, and are buying Bear shares and will vote “no,” hoping to push Bear into bankruptcy.
The Times is good as well with its look inside the tug of war.
The WSJ takes a long page-one look at who’s to blame for the housing bust and finds plenty to pass around. The paper says it’s a mix of do-gooderism gone overboard and laissez faire run amok.
But in hindsight, the failure stretches across government and across party lines. At bottom are two strong currents. From the Republican president to urban Democratic congressmen, homeownership was pushed as an overriding and unquestioned goal. And many significant attempts at regulation were obstructed by the prevailing belief that the economy did best when financial markets operated as freely as possible.
For our part, we think the WSJ places too much emphasis on blaming the societal and governmental push to help more people become homeowners. Let’s face it, that’s all a bunch of typically blown smoke without the financial engineering that in fact was the driving force behind the feeding frenzy of shoddy lending. Banks don’t lend because the president or congress say it would be great if more low-income people owned homes, they lend because they can make money.
The game was on when the wizards of Wall Street figured out how to bundle the mortgages of high-risk subprime borrowers into packages that garnered AAA investment ratings from the credit-ratings firms and when they figured out they didn’t care what was in the loans since they could make them, bundle them and sell them off to other suckers.
The WSJ is, however, dead on in emphasizing the role of regulation that was practically non-existent.
In 1999, Democrats, inspired by a groundbreaking antipredatory lending law in North Carolina, sought a federal equivalent. Predatory loans are typically described as those that involve excessive fees and high interest rates. Generally, such abuses occur in the market for subprime loans, those for people with weak credit records or high debt in relation to their income. Republicans, who controlled Congress, blocked the antipredatory legislation, arguing it would interfere with legitimate lending
From 2000 on, Democrats continued to introduce bills aimed at safeguarding against alleged predatory lending.
But they were blocked by Republicans who said markets should run free. And thus, the epidemic of fraud that is one of the primary drivers behind the collapse of the home market (see a good example in today’s LAT).
Despite our disagreement on its emphasis, this is an important story and a must-read.
Will the SEC nail Schwartz?
In the credit-where-credit-is-due file: the SEC is investigating Bear Stearns for its activities in the weeks and months leading up to its collapse.
The WSJ reports that the SEC may be investigating what Bear execs said last week as the run on the bank was unfolding.
The SEC could be looking at what traders were saying about Bear’s liquidity and ability to stay in business. Rumors circulated widely that in the weeks leading up to the Fed’s intervention, hedge funds sold Bear short—sold borrowed shares with the intention of profiting from a price decline—before forcing Bear into a desperate rescue by pulling business from its prime brokerage. It’s difficult to prove market-manipulation cases, especially concerning rumors
On Monday, March 10, Bear Stearns’s CEO Alan Schwartz stated his firm’s “balance sheet, liquidity and capital remain strong.” He also made reassuring statements Wednesday on CNBC. A call to Mr. Schwartz’s office wasn’t returned. Mr. Schwartz’s statements have angered some on Wall Street, further fueled when Bear was ultimately sold to J.P. Morgan for $2 a share.
Mr. Schwartz’s statements ticked us off then and they do now. This has been something of a hobby horse for us in recent days and we applaud the administration for looking into his, well, lies.
In other good news, the WSJ says Bear Stearns execs are walking away with little to nothing. Of course, this being Wall Street, “little to nothing” means millions of dollars in some cases:
Including shares that they own outright, Mr. Schwartz’s stake would be valued at roughly $2.9 million, Mr. Cayne’s at about $13.1 million, Mr. Greenberg’s at about $542,000, and Mr. Molinaro’s at roughly $1.1 million, the Reda firm said. In February 2007, the firm’s top officers held stakes collectively valued at nearly $2 billion.
And here’s something the SEC may want to look at closely:
Each man sold previously restricted shares last December, shortly after the shares vested and before Bear Stearns’s stock plummeted in value. Mr. Schwartz sold shares valued at about $6 million, Mr. Cayne sold about $15.4 million, Mr. Molinaro roughly $2.5 million, and Mr. Greenberg $8.8 million.
Does anyone understand this thing?
Finally, we like David Leonhardt’s column on A1 of The New York Times today about how hard it is to understand this crisis and what caused it that even Wall Street doesn’t quite get it.
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question: “Can you try again?”