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Bob
At 08:28 AM 3/24/2008, you wrote:
>Hussman has interesting opinion on the BSC matter:
>
>--------------------------------------------------------
>
>March 24, 2008
>Why is Bear Stearns Trading at $6 Instead of $2?
>
>John P. Hussman, Ph.D.
>All rights reserved and actively enforced.
>Reprint Policy
>
>Well, the ECRI (one of the more reliable private economic analysis
>groups) has finally thrown in the towel "With the Weekly Leading
>Index having dropped more than 13 points in the last nine months, it
>is exhibiting a pronounced, pervasive, and persistent decline that is
>unambiguously recessionary."
>
>The possibility of a "bear market rally" aside, if the S&P 500 has
>already set its low, it will have been the first time that the market
>has responded to a similar economic downturn with less than a 20%
>loss on a closing basis. If we define the recent downturn as a bear
>market anyway, the recent low will represent the highest level of
>valuation that has ever prevailed at the bottom of a bear market. I
>expect neither of these to be true for long, but as usual, we'll
>respond to the evidence as it unfolds without the need to forecast
>any particular scenario.
>
>Though our investment horizon of interest is a complete market cycle,
>we don't generally think in terms of bull and bear markets, because
>they can only be determined in hindsight. We prefer observable
>measures that allow us to identify the prevailing state or "Market
>Climate" at every point in time. We don't expect various Market
>Climates to overlap tightly with actual bull or bear markets.
>Instead, we expect that, on average, the return/risk profile
>in "favorable" Market Climates will significantly exceed the
>return/risk profile in "unfavorable" Market Climates. Accordingly, if
>we accept a greater amount of risk during favorable conditions, and
>less during unfavorable conditions, we expect to perform strongly
>at controlled risk over the complete market cycle.
>
>For now, we remain defensive, but we recognize the potential for
>a "bear market rally" despite conditions that, as yet, do not provide
>enough evidence to warrant removing a significant portion of our
>hedges.
>
>Why is Bear Stearns trading at $6 instead of $2?
>
>As I emphasized last week, the large "term financing" and "term
>securities lending" programs initiated by the Fed do not expose the
>Fed to default risk in mortgage collateral it accepts from the banks
>that act as primary dealers. Even if the underlying securities
>default, those facilities involve repurchase agreements, so the bank
>putting up the collateral has to repurchase the collateral at the
>original price plus interest after a term of 28 or 90 days. The Fed
>only stands to lose if the bank itself fails, and so spectacularly
>that the bank's liquidation value goes negative even after zeroing
>out bondholder claims and stockholder equity. Even in the present
>environment, this is unlikely.
>
>Alarmingly, immediately after the pixels dried on last week's comment
>(noting "the Fed is emphatically not taking the default risk of the
>mortgage market onto itself" with these term facilities), details
>emerged that the Fed had agreed to a very different deal in its
>attempt to rescue Bear Stearns. This is a major and ominous departure
>from historical Fed policy, and from legality.
>
>I'll cut straight to the chase.
>
>Bear Stearns is trading at $6 instead of $2 because unelected
>bureaucrats went beyond their legal mandates, delivered a windfall to
>a single private company at public expense, entered agreements that
>violate the the public trust, and created a situation where even if
>the bureaucratic malfeasance stands, the shareholders of Bear Stearns
>will either reject the deal or be deprived of their right to
>determine the fate of the company they own. Very simply, Bear Stearns
>is still in play. Still, when all is said and done, my own impression
>is that the ultimate value of the stock will not be $2, but exactly
>zero.
>
>In effect, the Federal Reserve decided last week to overstep its
>legal boundaries going beyond providing liquidity to the banking
>system and attempting to ensure the solvency of a non-bank entity.
>Specifically, the Fed agreed to provide a $30 billion "non-recourse
>loan" to J.P. Morgan, secured only by the worst tranche of Bear
>Stearns' mortgage debt. But the bank J.P. Morgan was in no
>financial trouble. Instead, it was effectively offered a subsidy by
>the Fed at public expense. Rick Santelli of CNBC is exactly right. If
>this is how the U.S. government is going to operate in a democratic,
>free-market society, "we might as well put a hammer and sickle on the
>flag."
>
>What is a "non-recourse loan"? Put simply, if the homeowners
>underlying that weak tranche of debt go into foreclosure, they will
>lose their homes, and the public will lose as well. But J.P. Morgan
>will not lose, nor will Bear Stearns' bondholders. This will be an
>outrageous outcome if it is allowed to stand.
>
>In my view, the deal would be palatable if J.P. Morgan was to remain
>fully responsible for any losses on the "collateral" provided to the
>Federal Reserve, assuming shareholders were to consent to the buyout.
>As it stands, Congress should quickly step in to bust the existing
>deal and demand an alternate resolution, by clearly insisting that
>the Fed's action was not legal.
>
>The Fed did not act to save a bank, but to enrich one. Congress has
>the power to appropriate resources for such a deal by the
>representative will of the people the Fed does not, even under
>Depression era banking laws. The "loan" falls outside of Section 13-3
>of the Federal Reserve Act, because it is not in fact a loan to
>either Bear Stearns or J.P. Morgan. Bear Stearns is no longer a
>business entity under this agreement. And if the fiction that this is
>a "loan" to J.P. Morgan was true, then the only point at which
>the "collateral" would become an issue would be in the event that
>J.P. Morgan itself was to fail. No, this is not a loan. It is a put
>option granted by the Fed to J.P. Morgan on a basket of toxic
>securities. And it is not legal.
>
>The deal was made under duress, to the benefit of a private company,
>on the basis of financial assurances that the bureaucrats involved
>had no business making. The Federal Reserve is going to put up public
>assets and accept default risk so that Bear Stearns' own bondholders
>are effectively immunized?! That's not sound monetary policy it's a
>picnic for insiders, bought and paid for through the abuse of public
>funds by government officials too unprincipled even to recognize the
>abuse. The only good thing about this deal is that it buys time while
>principled ways of busting and restructuring it can be settled.
>
>This is not an issue of letting Bear Stearns "fail" on the claims of
>its customers and counterparties. Nobody wants that. The issue is the
>method by which it was rescued who was protected, and who was not;
>why a consortium was not used instead of a single firm; why the
>claims of Bear's bondholders should be secure while the public bears
>the risk of the toxic waste foisted upon us. This deal should, and I
>believe will, be restructured. J.P. Morgan will cry foul, but that
>will be like a child who found the Easter basket and is now forced to
>share the chocolate. Bear Stearns is worth more than zero in
>acquisition, provided that the bondholders take an appropriate loss.
>
>As of November's 10K report, Bear Stearns had $9 billion in unsecured
>short-term debt, and $66 billion in long-term debt. The $12 billion
>in shareholder equity, of course, is gone. Any portion of the debt
>that is unsecured should be the first to fall. If Bear Stearns is
>worth $2 a share to somebody (provided $30 billion of "non-recourse
>loans" from the Fed), and yet Bear's bondholders and even the
>unsecured lenders can still expect to be paid off on over $75 billion
>of debt (J.P. Morgan assumes that obligation as part of the buyout),
>then the public guarantees aren't required in the first place. What
>is required is that Bear's bondholders take a loss, as they should,
>rather than the public doing so.
>
>In the unlikely event the value of Bear Stearns is negative after
>entirely zeroing out both shareholder equity and bondholder claims
>then and only then is there a problem for Bear's customers and
>counterparties. But in fact, J.P. Morgan is already willing to take
>on all of Bear's assets and liabilities, including over $75 billion
>in debt to Bear's bondholders, for $2 a share. This is an indication
>that bondholder's claims would not even be wiped out in a full
>liquidation. Surely, whatever loss is required to transfer the
>ownership of the company should be taken by the bondholders, not by
>the public.
>
>Again, this is not water under the bridge, and the deal struck last
>week should not be allowed to stand if we care at all about the
>integrity of the capital markets. The Long-Term Capital crisis was
>resolved by a consortium of financial institutions providing capital
>in return for ownership. The panic of 1907 was resolved the same way.
>This deal should be busted, and fast. If there's not a single buyer
>that will take on both the assets and liabilities without the
>government assuming private default risk, Bear's assets should be put
>out for bid, Bear's bonds should go into default, and by the
>unfortunate reality of how equities work, Bear's shareholders
>shouldn't get $2 they should get nothing.
>
>Bear's stock is selling at more than $2 for two reasons one is that
>the market evidently believes there is some chance for the deal to be
>busted, either by Congress or by shareholder rejection. And second,
>because Bear's bondholders are frantic to own the stock so they can
>vote for this lousy deal to go through. After all, buying up a few
>hundred million in stock to secure $75 billion of debt doesn't seem
>like a bad trade. Whatever happens, this is not over, for the simple
>reason that it is wrong.
>
>The U.S. economy will get through this without the requirement of
>massive public bailouts. What is required, however, is that the stock
>and bondholders of financial companies take due losses. Customers and
>counterparties need not, and I expect will not, be harmed. The value
>of the shareholder equity and debt issued by most financial
>institutions is ample buffer. In general, writedowns against
>shareholder equity alone will be enough, provided that regulations
>are revised to allow institutions to continue servicing existing
>financial commitments on the basis of more flexible capital
>requirements.
>
>If the market was "certain to crash" in the event that Bear Stearns
>failed, then the market is certain to crash anyway, because Bear
>Stearns wasn't the last shoe to drop it was one of the first.
>Unfortunately, we're standing in a shoe store. Wasn't the
>market "certain to crash" without the Fed's surprise rate cut in
>January too? At what point will investors figure out that the
>liquidity problems are nothing but the precursors of insolvency
>problems? At what point will investors stop begging the government to
>save private companies and recognize that the losses should be taken
>by the stock and bondholders of the offending financial institutions?
>If the Fed and the Treasury are smart, they will act quickly to
>figure out how to respond to multiple events like we've seen in
>recent days, to expedite turnover in ownership and quickly settle the
>residual claims of bondholders, without the kind of malfeasance
>reflected in the Bear Stearns rescue.
>
>As for the future of the free markets, Dylan Thomas comes to mind:
>
>Do not go gentle into that good night
>Rage! Rage against the dying of the light
>
>The Fed overstepped and the Treasury overstepped. At the point where
>unelected bureaucrats pick and choose who to subsidize who prospers
>and who perishes in a free capital market, and use public funds to
>do it, more is at risk than just $30 billion. Instead, we cross a
>line, and stumble off a very clear edge down an interminably slippery
>slope. We speak up now, or forever hold our peace.
>
>On the subject of speaking up, the essays in the special section of
>the Washington Monthly No Torture, No Exceptions are worth
>reading. They come from both sides of the political aisle. I am
>troubled that as a nation, both in economics and in foreign policy,
>we have become far too willing to sacrifice principles for what some,
>I think falsely, perceive to be an increase in security. But once we
>begin to violate our principles, we should realize that nothing else
>is secure.
>--------------------------------------------------------
>The original is here:
>
>http://www.hussmanfunds.com/wmc/wmc080324.htm
>
>
>
>
>------------------------------------
>
>Yahoo! Groups Links
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>
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