THE BASIS POINT

Regulators Grill Fed on Bear’s ‘Risky Business’

Timothy Geithner, the architect of the Bear Stearns BailoutAfter two days of Congressional hearings exploring the Bear Stearns bailout, it’s bailout burnout. Lawmakers grilling those who brokered the $2-per-share Bear Stearns bailout during a long, strenuous weekend is not unlike the mom in Risky Business grilling her son Joel (Tom Cruise) about why her crystal egg got cracked while she was out of town. The details are complex, but deals were made in a fluid situation and everything seems like it’s back to normal now. Roll credits.

But instead, we we listen to lawmakers recite their stump speech messages about how they need to protect their taxpaying constituents, then they acquiesce on every point they’re trying to enforce about the Fed-assisted bailout of Bear Stearns–because they have to, because the deal already happened. Not that these hearings aren’t important, but after the Fed Chairman’s testimony, the Q&A sessions are exactly that: message opportunities for Senators. They don’t accomplish much else because all the real work is done by the market players.

Markets simply move too quickly for regulation and are too smart for regulation. Even Henry Paulson last week used the term “Regulatory Arbitrage” when referring to the repeal of Glass Steagall in 1999. Markets will always find a way to innovate … and they will always get in over their heads … and they will always correct. Cynicism and broad generalizations aside, here’s what we did learn from the last two days of testimony:

  • Lawmakers preferred a low price for a Bear bailout, since the bailout was taxpayer-assisted. Open markets, private sector lawsuits (probably much more formidable than regulator aftermath), and general Bear shareholder revolt eventually led to a $10-per share acquisition price instead of the originally proposed $2 price.
  • Led by New York Fed Chief Timothy Geithner, the Fed was very cognizant of a taxpayer liability and was the lead broker in the deal with JP Morgan Chase. He made decisions in the best interest of the public and painstakingly documented every decision.
  • During Q&A in the past two days of testimony, Ben Bernanke said that the Bear debt they’ve taken on their books will return par value or at a slight return as they sell this paper into the markets in coming months. The Fed has the luxury of time, Bear and it’s global counterparty network that comprise our markets did not. So the taxpayer won’t bear the $29 billion cost.
  • With it’s term securities lending facility, the Fed issues Treasury securities in exchange for primary dealer (and now investment bank) debt that these institutions can’t move at the present time. The Fed reviews this debt in the same manner a mortgage bank underwriter reviews a loan application and documentation package. If the borrower isn’t credible and the collateral isn’t of good quality, they won’t approve it. This is ostensibly why Bernanke said that they’re confident on a full return on the Bear (and other assets) they take on through their TSLF.

The biggest question that remains is whether this debt is in fact movable and it’s more a matter of tight credit markets rather than bad debt. Unlike Joel’s mom, we’ll find out eventually…