Q about the Lehman Brothers / Bear Sterns deal:

[Ilsa]

Is this a reasonable description of what went on with Bear Sterns?:

"Lehman Brothers is bailing out the paper buyers and sellers at Bear Sterns, people who sold derivatives of mortgage contracts, people who actually didn't do anything productive, they just created a market for gambling on risk."

[sharesunited]

1. Substitute JPMorgan-Chase for Lehman Brothers and you are close.

"Productive" is kind of a value judgment, though. It was more productive than casino gambling.

[Ilsa]

3. Oops. Sorry. got the names of the players wrong. thank you for your input. nt

[BadgerLaw2010]

2. What Lehman/Bear Stearns deal? Bear Stearns is being sold to JPMorgan.

If you do mean JPMorgan, that applies to some of what Bear did. It does not apply to the Bear employees, as Jamie Dimon is going to fire at least half of them (after they've had their stock value wiped out).

[Ilsa]

4. Oops. Sorry. got the names of the players wrong. I hate what is happening

to the employees. They are getting shafted, of course, like so many hardworking banking employees in the 1980s and 1990s. I feel really badly for them.

[TreasonousBastard]

5. Not entirely true. Bear wasn't only...

playing around with hedge funds and stuff, but handled trades for pension funds and many others.

If they had gone belly-up, hundreds of thousands of people might not be able to access their 401K's, pensions, personal stock portfolios, etc since it would all be tied up in bankruptcy court for years.

Dig around for info on the Whitehall Brokerage bankruptcy back in the 60s. Pretty much the same thing where Whitehall basically screwed up a lot of records and had to be bought out by Merrill Lynch or the whole system would have crashed.

Also dig around for info on the Penn Central bankruptcy when the Fed kept the discount window open 24/7 to avoid a monstrous liquidity crisis when all the P-C bonds suddenly became worthless. That was another time the Fed saved the world.

[Ilsa]

9. Thank you for taking the

time to fill me in. I'll look for those events online. I have a thin memory of Penn Central's problems, but I was pretty young then. I'll have to lookup Whitehall Brokerage.

Yeah, the assets and retirement funds of citizens have to be protected. Sorry I didn't make my understanding of that clear.

[HamdenRice]

6. No, it is more complicated than that

Bear Sterns was not bailed out, as I think your OP acknowledges. It was sold at a fire sale price to JPM/Chase. The value of BS's CEO's stake, for example, decreased from $1 billion to $61 million. No one is crying for a guy worth $61 million, but apply that same math to all the investment bankers, traders, brokers, secretaries, and other BS employees who owned BS stock, not to mention all the other shareholders of BS, and you can see that the owners of BS were largely wiped out.

As you point out, the purpose was to save BS's "counterparties" -- the many, many institutions and individuals who were in some way dealing with BS as clients -- from losing their money in a BS collapse.

Some of those counterparties were holders of derivatives, not necessarily all or even mostly mortgage backed security derivatives.

Because they sound exotic, most laymen think derivatives are just bets and that buyers of them are just gambling. That's not true.

Here is an example of a currency derivative in a real world setting. Suppose you have a business that imports raw materials from South Africa -- maybe titanium ore. You enter a long term contract with the South African mine to buy that ore every month for the next two years, guaranteeing both its availability to your factory and its price.

But South African titanium ore is likely to be priced in Rands or Euros, not dollars. You are worried that even though you locked in the Rand price of titanium ore, the dollar could keep going to go down, making the ore ever more expensive.

You would buy a Rand derivative -- something that imitated a Rand future, the right to buy Rands at a set price every month for the next two years. Now you have locked the availability of ore, its Rand price and its dollar price. If that derivative was issued by BS, however, if BS goes under, you lose your currency risk protection.

There are many real world used for derivatives that are not gambling -- they are the opposite of gambling, ie they are an attempt to reduce risk. Clients buy derivatives to reduce risk; investment banks like BS issued them took on that risk for a price.

If BS were allowed to go under, all those people who tried to buy "insurance" against market fluctuations would lose that protection.

[Ilsa]

7. Thank you so much. That was very thorough. I needed more about

info about derivatives being used to manage risk. I guess some of my comments were over-simplified. I know the purchase of BS was a complicated consideration. I thought I heard that the govt is still going to be plugging in about $30 bil.

I didn't mean for the comments to sound judgmental about the purchase of BS. We can't allow such a large organization to have difficulty in meeting its obligations.

Thanks again for the info and explanations.

[HamdenRice]

8. Your welcome -- and one more thing about the $30 billion

The fed is not giving any party $30 billion, so it's not really accurate to call this a bail out.

Mortgage backed securities are one of the main, if not the main, assets that banks and investment banks use to park their cash. When all the banks became afraid to buy and trade each other's mbs, that caused a "liquidity crisis," which just means there was little buying or selling or lending among banks.

The fed is saying to JP/Chase that if you need cash to finance the aquisition of BS's stock or pay its obligations, we will be ready to lend you cash taking mbs as collateral, the way, in the past, regular banks would. If all goes well, the fed will either not have to make those loans, or if they do, they will be paid back. In the past, when the fed has done this sort of thing, they have actually made money.

[Ilsa]

10. Wow. That's the best explanation yet. Thanks! nt