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New York Times, April 4, 2008 article


The New York Times

April 4, 2008

Testimony Offers Details of Bear Stearns Deal

WASHINGTON — Three weeks after the market crisis that forced the rescue of Bear Stearns, federal officials and senior Wall Street executives offered their first public account on Thursday of the harrowing four days of negotiations that led to a deal to sell the investment bank to JPMorgan Chase.

In testimony before the Senate Banking Committee, top officials from the Federal Reserve, the Treasury Department and the Securities and Exchange Commission strongly defended their actions, answering critics who have said that the government should have taken more aggressive steps months, or years, earlier to prevent the problems that are plaguing the financial markets.

Critics have also questioned bailing out creditors of one Wall Street investment firm possibly at taxpayers’ expense.

The officials responded that they had no choice but to act for the broader good of the markets and the economy. A failure to save Bear Stearns, said Timothy F. Geithner, the president of the Federal Reserve Bank of New York, would have led to “a greater probability of widespread insolvencies, severe and protracted damage to the financial system and, ultimately, to the economy as a whole.”

The testimony disclosed that Treasury Secretary Henry M. Paulson Jr. had insisted that Bear be paid a very low price for its stock by JPMorgan Chase. The testimony also offered more details about the pressures on Bear. The firm’s chief executive, Alan D. Schwartz, said that he thought on the morning of Friday, March 14, that he had engineered a loan, backed by the Federal Reserve Bank of New York, that bought him 28 days to find a solution.

But he said he realized that he had misunderstood the terms of the loan when the Fed decided later that day that the loan would last only through the weekend and that he had only until Sunday afternoon to find a buyer for the 85-year-old firm.

The testimony also disclosed that regulators were unaware of Bear’s precarious health and did not know until the afternoon of Thursday, March 13, that the firm was planning to file for bankruptcy protection the next morning.

Pummeled by market rumors of insolvency, the investment house lost more than $10 billion —or more than 80 percent — of its available cash in a single day. Only a few days earlier, the chairman of the S.E.C., Christopher Cox, had sought to calm investors, telling reporters that “we have a good deal of comfort about the capital cushions” at Bear and other large investment houses.

By Sunday, March 16, Federal Reserve and administration officials had orchestrated a $30 billion rescue of the firm, and the firm announced that its stock, which last year had been trading at $171 a share, would be sold to JPMorgan for $2 a share. (The offer was later revised to $10.)

Under questioning by Senator Christopher J. Dodd, Democrat of Connecticut, the committee’s chairman, both Ben S. Bernanke, the chairman of the Fed, and Mr. Geithner said they played no role in setting the price, which was one of the most controversial elements of the deal.

“We had no interest or no concern about the stock price that was evaluated,” Mr. Bernanke testified.

But in response to the same question, Robert Steel, a Treasury under secretary, said that his boss, Mr. Paulson, had said during the negotiations that the price should be low because the deal was being supported by a $30 billion taxpayer loan.

He said a lower price was desirable to make the broader point to the markets that by rescuing the bank, the government did not want to encourage risky behavior by other large institutions, a concept known as “moral hazard.”

“There was a view that the price should not be very high or should be towards the low end and that it should be — given the government’s involvement, that that was the perspective,” Mr. Steel said. “With regard to the specifics, the actual deal was negotiated or transaction was negotiated between the Federal Reserve Bank of New York and the two parties.”

“It was our perspective, as I said, that moral hazard wanted to be protected as much as possible,” he added, “and so therefore a lower price was more appropriate and there were lots of terms and conditions.”

Mr. Bernanke and Mr. Geithner said that in exchange for the $30 billion loan, the Federal Reserve Bank was given investment-grade securities and collateralized mortgage obligations, with the majority of them from government-sponsored institutions like Freddie Mac.

They said that under the terms of the deal, an investment manager retained by the Federal Reserve Bank would have 10 years to dispose of the assets. That would eliminate the need to sell the assets quickly in a fire sale. Moreover, JPMorgan Chase later agreed to absorb the first $1 billion of any loss that might occur on the loan.

“Our system has many strengths,” Mr. Geithner said. “But to be direct about it, I think we’ve suffered a very damaging blow to confidence in the credibility of our financial system.”

Mr. Cox, the S.E.C. chairman, testified that Bear’s failure on Thursday and Friday, March 13 and 14, to obtain financing even though it had what he called “high-quality collateral” was “an unprecedented occurrence.”

Mr. Cox strongly suggested in response to questions by several senators that the commission was investigating whether there may have been unlawful manipulation of Bear Stearns’s stock price in the days leading up to the run on the firm.

The Thursday afternoon alert to the commission led to a round of evening and early morning negotiations, and at 5 a.m. on Friday, members of the Federal Reserve voted over the telephone to grant a loan, through JPMorgan, to Bear Stearns.

Mr. Schwartz, Bear’s chief executive, said he thought the action had bought him 28 days to raise cash or find a buyer.

“We believed at the time that the loan and corresponding back-stop from the New York Fed would be available for 28 days,” Mr. Schwartz said. “We hoped this period would be sufficient to bring order to the chaos and allow us to secure more permanent funding or an orderly disposition of assets to raise cash, if that became necessary.”

But by the end of the day, with continuing problems surfacing and the downgrading of the firm’s credit rating, he said he was told by the Federal Reserve of New York that he had misunderstood the terms of the deal. He was told that the loan would expire on Sunday, and that he had to find a buyer for the bank by then — before the Asian markets opened. The decision, Mr. Schwartz testified, left him with no negotiating leverage as talks proceeded with JPMorgan.

“On Friday night, we learned that the JPMorgan credit facility would not be available beyond Sunday night,” Mr. Schwartz said. “The choices we faced that Friday night were stark: find a party willing to acquire Bear Stearns by Sunday night, or face what my advisers were telling me could be a bankruptcy filing on Monday morning, which could likely wipe out our shareholders and cause losses for certain of our creditors and all of our employees.”

Mr. Schwartz said his misunderstanding of the agreement was “an honest disagreement as to the words” of the loan.

“Everything happened on a very, very short time frame,” he said.

Asked about the adequacy of the price paid to Bear Stearns, Mr. Schwartz said he had no alternative.

“All the leverage went out the window when we were told we had to have a deal done by the end of the weekend,” he said.

James Dimon, the chairman and chief executive of JPMorgan Chase, offered a slightly different view on the question.

“Buying a house,” he said, “is not the same as buying a house on fire.”





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