You have probably seen this game on TV. The guy on the street offers to play a game with a passer-by where there are three cards, one red and the other two black. He moves the cards around and asks you to pick the red card. The first time or two you get it right, then the street guy offers to let you win some money at this. Before you know it, you've lost all your money. Often times there is a shill or confederate involved.
Well, in my opinion, we are getting into the same thing with the Fed. Today it was announced that JP Morgan bought Bear Sterns, a big investment bank that was about to go bankrupt. (People lost confidence in them and more or less made a run on the bank to get their money out. Bear Stearns is an investment bank, and for that reason, deposits, investments, etc. didn't have FDIC insurance. If the bank bit the dust, the customers would not get their money back through Uncle Sam.) The Fed is lending this private company, JP Morgan, money to buy the company at $2 per share. Last week it was worth $30 a share and earlier this month it was worth $70 a share. (One of the guys at Bear Stern said the building alone is worth $8 a share...talk about a motivated seller!) Anyway, the Fed is lending the money through a back-door method since there charter doesn't allow them to take collateral directly. They are taking bonds as collateral. Funny thing...these bonds are those good-old mortgage-backed securities that nobody really wants now because people are in default on a lot of the mortgages.
This is the 3-card Monte part: How different is it to take the bonds as collateral instead of the bonds themselves? I am not a banker, BUT to me it seems like a difference without a distinction. This will make things interesting down the road. What will the Fed do with this collateral? My guess is...NOTHING. They want the mortgages (and the houses that would be foreclosed on) even less than the banks. They are even less prepared to take care of a bunch of re-po'd houses than the banks, that's for sure. And as a quasi-governmental organization, I don't think they really want the doo-doo on their fingers that comes from kicking citizens out of their homes. The Fed is supposed to HELP people with their foreclosure problems (or at least be trying to prevent an economic collapse), not foreclose on them.
If the intent was to actually secure the loan to JP Morgan (and others who will soon come to Uncle Sugar for a hand out), they made a foolish move in accepting collateral they would never want to own. They will never hold Morgan's feet to the fire if they, too, can't perform. My feeling is that there isn't really any intent to collect on that loan. It's just to make the hand-out appear to be a loan, and thus more palatable to the public at large. I also think it is a trial balloon. If there is no outcry (which there won't be), we will be paying for more of these mega-loans, one way or the other.
So what's the big picture? I'm not sure yet. I think we will end up gumming things up by trying to fix them. I think the law of unintended consequences will kick in, and at some point, we will find ourselves in more trouble than we would have been if we let the market thrash these banks. Being greedy, they would involve themselves directly or indirectly with making loans to people who won't or can't pay, and the market needs to correct them.
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