Wednesday, July 02, 2008

Down with the Bear

If you have a long commuting trip, are stuck in a traffic jam, or don't know what to do to spend the weekend, I suggest you to pick up the latest Vanity Fair. No, not the Nabokovesque Miley Cyrus' (a.k.a Hannah Montana) photo shoot --that's in the past edition--, but this 8 pages long in the website version, or 16 full pages if you print it, journalist's investigation on the last days of the once mighty Bear Stearns.

It tells you how those big names in the financial world work, how influential the media is (CNBC, to be specific), and how the nervous Fed acted. If you don't know the different perceived style between Lynch, Sachs, Stanley, and Stearns in making money, like I do; or how important to speak up to the right news anchor is; or how close the Fed, Treasury, and Wallstreet are; then, perhaps, it's the right reading.

Here is what happened in that fateful night of the Bear.
That day was Dimon’s 52nd birthday, and he was celebrating with a quiet family dinner at Avra, a Greek restaurant on East 48th Street. He was irked when his private cell phone rang; it was to be used only in emergencies. On the line was Parr, who put Schwartz on as Dimon stepped outside onto the sidewalk. Schwartz quickly explained the depth of Bear’s plight and said, “We really need help.” Still irked, Dimon said, “How much?”

“As much as 30 billion,” Schwartz said.
“Alan, I can’t do that,” Dimon said. “It’s too much.”
“Well, could you guys buy us overnight?”
“I can’t—that’s impossible,” Dimon replied. “There’s no time to do the homework. We don’t know the issues. I’ve got a board.”

The people he should call, Dimon said, were at the Fed and the Treasury—the only place Bear could get $30 billion overnight. Still, Dimon promised to see what he could do to help. He hung up and dialed Tim Geithner at the New York Fed downtown. Twenty-first-century Wall Street is a highly interconnected world, with just about everyone lending billions of dollars to everyone else, and Geithner worried that Bear’s collapse might trigger a domino effect, taking down scores of other firms around the world; he urged Dimon in the strongest terms to think about somehow helping Bear. “Tim, look, we can’t do it alone,” Dimon said. “Just do something to get them to the weekend. Then you’ll have some time.”
In case you don't know the names: Jamie Dimon is the JP Morgan's CEO, Gary Parr a top investment banker of the Lazard Freres, Alan Schwartz the Bear Stearns' CEO, Tim Geithner the New York Fed's President.

A caveat, it's a journalist report, so don't expect for a heavy bibliography. Whether the account is true, let's wait for the responses from the parties mentioned.


  1. A name tells everything actually...

    Anyway, it's gonna be too long for me to comment.

    The relationship between Bearn's hedge funds, credit derivatives and the Fed is symbiotic in the context of financial market and economic development; as one is the user of the other for a mutual benefit.

    Bearn's hedge funds with their channelling and leveraging capacity are able to trade and play with credit derivatives as accessing credit markets sold by US banks in which Bearns doesn't have the capability of originating the credits.

    In fact, credit market for loans or bonds is the biggest available market in capital market in terms of volume, outweighing equity market. Bearns may then see an opportunity to take a big profit in credit market via credit derivatives as they can speculatively bet on default probability and interest rate movement. (if succeed)

    On the other hand, credit derivatives can provide lenders a broader and liquid market for transferring credit risks in order to capture wealthy investors via hedge funds.

    Imagine Bank Mandiri originates a huge credit facility to some national corporations or to nearly wealthy households. Then, one player, say Salemba's Fund, turns it into credit derivatives and catches the markets (foreign/domestic) as betting on the loans for/from a bunch of already wealthy investors. It's obvious if BI bails out Salemba because the root is Mandiri. (In some cases of the fail of Mandiri's loan team in assessing the loans)

    Any failure? Damn! why don't just they arrest BI or Mandiri's people?

    If Salemba fails, if Salemba succeeds, at least Salemba'll live as Salemba believes. No matter what they take from Salemba. They can't take away Salemba's dignity.

  2. A lot of people say that markets are self-correcting if left by themselves. However, the histories show again and again that markets are not left to themselves at the moments of their crisis.

    Supply and demand is a powerful analysis. But after reading a lot about financial crises, I suspect there are more to that. Narrative, language, institutions, power, networks, routines, culture are all intertwined.

    Even the bastion of capitalism needs more than just supply and demand.

  3. Roby has some points. If only market is self-correcting, why market is full of institutions? Why central bank is on earth? Even capitalism is an institution. That being said, deducing capitalism only to the mechanics of supply and demand is rather banal.

    Rizal has a good taste of narrative. I am a fan of his postings :) One might also consult Galbraith's The great crash 1929 for a mixture of narratives and smart jokes.

    A small story: When that crash hit my kampung in Minahasa, agriculture production in 1930s was even on the rise - against the "law" of supply and demand. Copra-producing for tengkulak (recall, institution!) was apparently one of the many causes.

    - Sonny

  4. Anymatters, let's get down with some numbers.

    The Bear played heavily in a derivatives market called credit default swap (CDS). The size of CDS market in 2007 is 45.5 tn US dollar.

    The US stock market size is 21.9 tn USD, mortgage 7.1 tn USD and US Treasury Market 4.4 tn USD. The US GDP is 14 tn USD. Indonesian GDP at purchasing power parity in 2007 is just 0.85 tn USD.

    The Bear itself was a counter-party of 10 tn USD over the counter swaps. Small wonder that the Fed shuddered on the idea of falling Bear.

    The real question is, of course, how big too big to be failed is --that allows the government to bypass the cost of moral hazard?

    Roby and Sonny, points are taken. I know next nothing to the theory of expectation making. Even I find it empirically problematic to accept Lucas' rational expectation theory.

    Yet I still think that somehow that seemingly irrational exuberance should have been able to be explained by the standard agent maximization approach --the way Stiglitz elegantly described credit rationing under asymmetric information, Akerlof Lemon, or Rudi Dornbusch exchange rate overshooting model.

  5. Thanks for the numbers, Rizal. Making me sure how big is the magnitude of credit derivatives. However we need to respect those who have made that kind of market works (although failed).

    Again, I play with imagination. There are 10 economically and academically average students taking study loans from Bank A (scholarship is for the academically above average, right?). The total loans + interest value is say 1100. Then Bank A buy insurance costing 500 from Salemba's Fund covering some student who may have a miserable life can't find a job and paying back the loan on time.

    Salemba here bets on that all students have a good life and paying back the loans, and may walk with 500. It's all good.

    Even failed, Salemba has bought another insurance from Depok's Fund costing 400, and may walk with 100. Depok is now taking the bets. It's all good.

    Apparently Depok has done something (coaching, outsourcing, recruiting etc) to the students so that all of them can have a good job, happy life and paying the loans.

    Would government help Depok? Every man in this story is a good man.

  6. fyi, last year i had 3 posts related to credit derivatives, when i was really curious on that topic.

    Credit derivatives

    Hypothetical simlations of credit derivatives

    Credit derivatives played by hedge funds

    please comment if something's wrong or needs update.

  7. rizal, sorry for the lame comment but that sounds like a financial gossip column to me... but of course... it's vanity fair. one should never undermine the source of information... in fact, at any information...