Crises of Confidence in the Markets
Tuesday, March 18, 2008
Investors dumped stocks of the nation's major investment firms yesterday after a rescue plan for one of the biggest, Bear Stearns, exposed unexpectedly large cracks in the foundation of the financial system.
Even after the Federal Reserve on Sunday night offered an unprecedented credit line to investment banks, their shares plummeted. Lehman Brothers was down 19 percent. Europe's largest bank, UBS, which has recorded huge losses from mortgage investments like those at its U.S. counterparts, suffered its sharpest drop in European trading in nearly 10 years.
U.S. currency traders launched a furious sell-off of the dollar immediately after the Fed acted Sunday, some staying up all night on concerns, they said, that major U.S. bank failures could be on the horizon. Major stock market indicators swung wildly, with the Standard and Poor's 500-stock index falling as much as 2.4 percent but ending 0.9 percent lower. The Dow Jones industrial average rebounded from early losses, finishing up about 0.2 percent on the strength of J.P. Morgan Chase, which has agreed to purchase Bear Stearns for a fire-sale price.
President Bush said his administration is "on top of the situation" in dealing with the slumping economy, praising the Fed for its steps. "One thing is for certain -- we're in challenging times. But another thing is for certain -- that we've taken strong and decisive action," he told reporters after meeting with Treasury Secretary Henry M. Paulson Jr. and other economic advisers.
But critics accused Bush of bailing out big Wall Street firms while ignoring ordinary homeowners.
The wild ride came after the Fed offered Bear Stearns a financial lifeline but demanded control over the bank's fate in return for keeping it out of bankruptcy. The arrangement, which involved J.P. Morgan agreeing to buy Bear Stearns for only $2 a share, signaled that investment banks may be even more vulnerable than had been previously known. Bear Stearns shares closed at $30 on Friday.
"Bear Stearns's demise should probably be viewed as the first of many," Richard Bernstein, chief investment strategist for Merrill Lynch wrote in a research report. "Sentiment is just beginning to catch on as to how broad and deep the credit market bubble has been."
Just a week ago, top Treasury officials said they opposed any plan that put taxpayer dollars at risk by buying up troubled mortgage securities or bailing out investment firms. But when these officials examined Bear Stearns's books, they discovered the bank was essentially out of cash and urgently decided to back the Fed taking on these securities to save the banks.
"Last week, the position of the Bush administration was to let markets correct themselves and to allow no bailouts and no subsidies," said William W. Beach, senior fellow of economics at the Heritage Foundation. "Somewhere over the last four days, that policy changed. They discovered the rules of the road just didn't apply."
Paulson bristled at the notion that the Fed had bailed out big banks, telling reporters: "If you would ask the Bear Stearns shareholder in terms of what has happened to their value, then I don't think any of them would think that this has been a good outcome for them."
The Bear Stearns debacle has revealed a central reality of Wall Street: Investment firms live and die on confidence.
Bear Stearns made most of its money by providing loans and services to hedge funds so they could make massive investments. Bear Stearns's clients include some of Wall Street's top investors, such as George Soros, the billionaire hedge fund manager.