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Northern Rock And Bear Stearns - A Comparison

When the Federal Reserve Bank facilitated the takeover of Bear Stearns by JP Morgan, they provided an object lesson in central bank responsibility which the Bank of England should study and digest.
When the Federal Reserve Bank facilitated the takeover of Bear Stearns by JP Morgan, they provided an object lesson in central bank responsibility which the Bank of England should study and digest.

The Fed's intervention is startling due to the fact that Bear Stearns is not a bank. It is a financial intermediary, that is, an investment company. There were no lines of retail customers outside their New York office, waiting to withdraw their life's savings.

However, the Fed decided that Bear Stearns could not be allowed to fail.

The speed at which events unfolded is remarkable. Bear Stearns went to the Securities and Exchange Commission on 13 March, stating that it was preparing to file for bankruptcy. On the very same day, JP Morgan announced that it was lending some US$ 30 billion to Bear for a month, underpinned by the Fed. By Sunday 16th, JP Morgan had made an offer of US$ 2 a share which valued Bear at a derisory US$ 236 million. On Monday 17th, JP Morgan staff were installed at Bear and effectively took control of operations.

Although Bear does not have retail depositors, the company is at the center of a myriad of major international deals and positions. Simply unraveling these positions would be a prolonged and convoluted process which would also draw other US institutions into the mire. The Fed did not want the contagion to spread to other banks.

Shareholders are dismayed that Bear has been sold for US$ 2 per share and that JP Morgan have acquired major assets at a fire sale price. Bear's stock hit US$171 last year and closed at US$ 30 just before the takeover. However, there are very few commentators who have criticized the Fed's action.

The Fed also took action to boost the standing of Lehman Brothers who were the object of negative market rumors. They apparently telephoned numerous US and international banks stating that Lehman was solvent and enjoyed the Fed's confidence. Despite a price fall of 20% on 17 March, Lehman shares rose by 45% on Tuesday when it issued a company report.

It should not be assumed that the Fed will support any US financial institution. Only the major players enjoy this special privilege.

Carlyle Capital is listed on the NYSE Euronext exchange at Amsterdam, although it is managed from New York. It administers US$ 81 billion of investments and has real estates deals to the value of US$ 229 billion.

The fund achieved the dubious distinction of leveraging its equity in excess of 32 times, and used this debt to finance the purchase of residential mortgage backed securities. These were issued by Freddie Mac and Fannie Mae.

It is these very same securities, with treble A ratings, which have percolated through the international banking system. The downgrading of these securities triggered the current credit crisis.

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