Bear Stearns - What's Going On & Why is This Important to Know About?

Bear Stearns Cos., on the brink of collapse from a lack of cash, received emergency funding from the Federal Reserve and JPMorgan Chase & Co.

This is the largest government bailout of a U.S. securities firm in history and reveals that the fear of credit turmoil has spread to the core of the U.S. financial system. This follows last week’s move by the Fed when it announced an industry-wide rescue package that would provide as much as $200 billion in loans to banks and investment houses and allow them to put up risky home-loan packages as collateral in an effort to stem a global credit crisis that began last August. As you may recall, last August is when we began to hear about rising mortgage loan defaults for subprime mortgages - loans provided to borrowers with weak credit histories.

Bear Stearns's troubles have been perceived to be part of a larger threat to securities firms as well as the financial markets in general. "It was a strong action by the Fed and they did so because some financial institutions that borrowed money to buy securities in the housing industry must now repair their balance sheets before they can make further loans," President Bush said yesterday (3/14/08). "Today's actions are fasting moving, but the chairman of the Federal Reserve and the Secretary of the Treasury are on top of them and will take the appropriate steps to promote stability in our markets."

The emergency funding will supply to Bear Stearns short-term relief for an initial period of 28 days. The Fed’s arrangement allows JP Morgan Chase to borrow from the Fed and to re-lend it to Bear Stearns while collateral from Bear Stearns would back up the loans. JP Morgan is serving as a conduit for the loans for Bear Stearns; however, the Fed and not JP Morgan will bear the risk if the loans are not repaid according the Federal Reserve officials.

The problems caused by the sub-prime lending crisis have been greater and more complex than anyone might have anticipated; however, how does one ever anticipate something like this, at least to this level? This emergency funding is a difficult decision for the U.S. Tresury and Federal Reserve, as bailouts always are. Why? Because they are usually very expensive, no guarantee of further deterioration of the company or industry involved, and may encourage other companies or industries to engage in risky behavior now or in the future and thus rely upon similar measures by the government. However, weighed against the alternative of not only Bear Stearns going under, but potentially other U.S. securities firms and banks also failing, this was deemed the best choice. Why isn’t this problem simply isolated to Bear Stearns? Because each securities firm is incredibly intertwined with others in a myriad of loans, credit agreements/lines, etc. By letting Bear Sterns go under, the fear would be that the consequences to the overall financial markets and economy might be too great a risk.

Some people tell me that they don’t care what happens on Wall Street or the overall economy because it doesn’t have any real impact or effect upon real estate. Well, not true. As you can see, there are times when Wall Street effects life on your street.

Stay tuned on this issue and others by continuing to read this blog.