BEAR STEARNS MELTDOWN (CONT'D)

ECONOMIST - A century after John Pierpont Morgan bailed out Wall Street, his bank is at it again. In a dramatic move on Friday March 14th, the Federal Reserve Bank of New York and JPMorgan Chase made emergency funding available to Bear Stearns after other market players lost confidence in the beleaguered investment bank as a trading partner. . .

The meltdown at Bear, which began last summer when two of its hedge funds blew up, is a classic example of how liquidity problems and ebbing confidence can quickly turn into a solvency crisis, especially for investment banks, which are more reliant on short-term funding than commercial banks. . .

Bear’s shares initially jumped on news of the bail-out but crashed after the market opened on Friday. At one point, half of its market value had been wiped outan unprecedented one-day fall for a big Wall Street firm in modern times. According to reports, clients were desperately trying to pull assets out of Bear on Friday. . .

Though Bear is the smallest of the “big five” Wall Street investment banks, it is the most exposed to credit markets, particularly mortgages, relative to its size. Its larger peers can take comfort in being more diversified, but they too are largely at the mercy of short-term funding markets and the confidence of counterparties. Others will be losing sleep, too. Bear’s woes will only exacerbate worries about highly-leveraged hedge funds, an increasing number of which are finding it hard to stay afloat as their prime brokers jack up margin calls. A fund affiliated with Carlyle Group, a big private-equity firm, crashed this week.

Ironically, the intervention came a day after Standard & Poor’s, a rating agency, said that the worst of banks’ write-downs related to subprime mortgagesBear’s biggest weakness may soon be over. But if the extraordinary events of the past day demonstrate anything, it is that investment banks are black boxes, and what really matters is not what sits in them but what their counterparties fear may be lurking inside. If others find themselves in Bear’s awful predicament, there will be little the Fed can do to forestall a rout.

NY TIMES The sudden collapse of a major player could not only shake client confidence in the entire system, but also make it difficult for sound institutions to conduct business as usual. Hedge funds that rely on Bear to finance their trading and hold their securities would be stranded; investors who wrote financial contracts with Bear would be at risk; markets that depended on Bear to buy and sell securities would screech to a halt, if they were not already halted. “In a trading firm, trust is everything,” said Richard Sylla, a financial historian at New York University. . .

Commercial banks, mutual fund companies and other big financial firms with deep pockets would presumably weather such turmoil. Firms that traded extensively with Bear Stearns could be at great risk if the bank failed.

For individual customers, the Federal Deposit Insurance Corporation insures deposits up to $100,000. Furthermore, when a Wall Street firm fails, the Securities Investor Protection Corporation steps in to take over customer accounts. . .

Hedge funds rely on Wall Street for a range of services from the humdrum, like holding their securities, to the critical, like providing loans they use to increase their bets. As Wall Street has buckled under multibillion-dollar write-downs, the firms have cut financing to hedge funds and asked the funds to put up more assets to back their borrowing, forcing managers to sell en masse.

This has caused a series of hedge fund blowups, including Carlyle Capital, an affiliate of the powerful private equity firm Carlyle Group; Peloton Partners, a hedge fund founded by former Goldman Sachs traders; and Drake Capital, a blue-chip fund that has been struggling.

A manager at one hedge fund that uses Bear Stearns as its prime broker said his firm had been nervously watching the situation. The manager, speaking on the condition that he or his fund not be identified, said the fund had lined up backup firms that could clear its trades and keep its portfolio, though as of Friday afternoon it had not left Bear Stearns. . .

Compounding the problem, some big investment banks this week stopped accepting trades that would expose them to Bear Stearns. Money market funds also reduced their holdings of short-term debt issued by Bear, according to industry officials. “You get to where people can’t trade with each other,” said James L. Melcher, president of Balestra Capital, a hedge fund based in New York. “If the Fed hadn’t acted this morning and Bear did default on its obligations, then that could have triggered a very widespread panic and potentially a collapse of the financial system.”

INDEPENDENT, UK - Bear Stearns has appeared the most fragile of Wall Street's major investment banks since the collapse of two internal hedge funds last July provided the first clues about the scale of the credit crisis that was beginning to unfold. But shares across the banking sector plunged on yesterday's developments as analysts feared that the Fed's willingness to intervene suggested that Bear's future was pivotal to the banking system, and that its failure could cause losses to cascade through its trading partners. Bear Stearns shares went into freefall, closing down 47 per cent.. . .

Bob McDowall, the senior analyst at the financial sector research firm Tower Group, said: "This situation demonstrates what a loss of confidence in an investment bank can do to its ability to operate. These firms need capital and financing capabilities to run their business, and without the confidence of their trading partners, they come to a screeching halt.". . .

AMBROSE EVANS-PRITCHARD, TELEGRAPH - Big American finance houses have collapsed before. Continental Illinois required a $4.5bn bail-out in 1984 after coming to grief in Texas as the oil boom deflated. The giant hedge fund Long Term Capital Management was saved by a club of banks in 1998 under the guidance New York Federal Reserve. The fund blew up after Russia's default, which ravaged its portfolio of Danish, Italian and Spanish bonds. On both occasions the US economy was in rude good health. The damage was quickly contained.

The implosion of Bear Stearns is more dangerous.

A host of other banks, broker dealers, and hedge funds have played the same game, deploying massive leverage at the top of the credit bubble to eke out extra yield. Dozens of them are saddled with the same toxic debt - sub-prime property, credit cards, auto loans, and mountains of unsold paper from the merger boom.

This time the market for default insurance is flashing bright red warning signals across the entire spectrum of US finance. . . Had the Fed delayed, many traders believe Wall Street would have plunged through resistance levels risking a full-fledged crash. . .

You have to go back to the banking crisis of the Great Depression to find a moment when the financial system as a whole seemed so close to the precipice.

Although 4,000 US banks failed in the early 1930s (mostly small ones), it was a long-drawn out affair. The bank runs began in the Prairies as falling food prices caused farmers to default in 1930. It seemed to be a local problem. . .

In those days the contagion spread slowly to the rest of the world. It is much swifter now. . .

Debt levels have been much higher than in the Roaring Twenties; the new-fangled tools of structured credit are more opaque: the $415 trillion nexus of derivative contracts is untested. Nobody knows for sure if the counter-parties are able to deliver on vast IOUs, or whether the construct is built on sand.

What keeps Federal Reserve officials turning at night is fear that the "financial accelerator" will now set off a vicious downward spiral. There is a risk of "very adverse economic outcomes," said Fed vice-chair Don Kohn.

Albert Edwards, global strategist at Societe Generale, said the toppling banks are merely a symptom of a deeper rot. "The banks are not the problem. Nor even the grotesquely leveraged funds. The problem is that an economic bubble financed by ridiculously loose monetary policy is unraveling," he said.