Thursday, March 27, 2008

BS, the story so far

The fog seems to be lifting. The blurry profile starting to be seen is this one:

  1. BS went to the Fed asking for a bailout.
  2. The Fed considered that contagion and meltdown would likely result. But it declined to open the doors to moral hazard and looked for alternatives.
  3. It might have considered nationalization, but rejected it for several reasons, sp. legal. It might have considered opening the discount window to BS, but decided it would be useless for it, pouring money into an already tainted business and boosting moral hazard in the process. (The window was later opened to other investment banks to stop contagion, specially in the case of Lehman Brothers.)
  4. Instead, it helped engineer a buyout via JP, which had access to the discount window and a solid balance sheet. While this amounts to what is now being called the "socialization of losses/risk", it would prevent contagion.
  5. JP would benefit enormously, but what was important was (a) preventing contagion and (b) that BS shareholders were publicly punished. Thus the $2 price ($0 would have delayed the deal as BS shareholders kicked and screamed all the way to the bankruptcy window, even if they'd get nothing through it).
  6. But JP was not entirely happy because it wanted to keep BS's "talent" pool and keep it happy. These employees would have fled in disgust at $2 per share.
  7. So JP pretended shock at a terrible glitch in the contract it signed, though it might have even included that glitch on purpose (at the very least, it seems to have been aware of it at the signing of the contract). This gave them the excuse to renegotiate with the aim of keeping BS employees, while the Fed could only watch since it couldn't afford to let the deal fail.

Conclusion: the Fed had the right idea given the constraints it faced, but got stiffed during the implementation. In the end, it's been duped into bailing out the JP/BS combo (it "socialized losses while keeping profits private"; I like that new catchphrase) and, perhaps, into fanning the moral-hazard fire.


Gabriel said...

"Talent"? That's... untimely, to be polite about it.

But I guess it's true that these finance and banking types live in a world of their own.

ram said...

You got it! (I mean, the reason for putting the word between quotes.)

It's funny to think of "talent" when the markets are screaming in pain thanks to the talented believe that the laws of the world had been reinvented.