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Bear Stearns Is A Lesson To Us All

March 27, 2008

Bear Stearns Is A Lesson To Us All

The Bear Stearns’ takeover by JP Morgan shows what can be achieved if there are banking authorities able to operate with the fleetness of foot necessary in today’s world of instant communications in global financial services.

The comparisons between the quick fire takeover last week of the US investment bank, Bear Stearns, in the US and the nationalisation of the UK high street operation, Northern Rock, are unpleasant. No one can avoid recognising the speed at which the US government, the Federal Reserve and JP Morgan acted in resolving the bankruptcy which undoubted faced Bear Stearns. Our government and the Bank of England faced with a similar situation late last summer chose to ignore the overtures of Lloyds TSB whose putative rescue package for Northern Rock was dismissed. As a result the British taxpayer is now paying the price and will likely do so for many years to come.

The staff at Northern Rock were told that nationalisation would not mean redundancies but now the news has leaked (as it always does with this government) that 2,000 jobs are likely to go at the Newcastle-based bank. In America no one is making any pretence that the job losses at Bear Stearns globally will be anything but substantial in the near term.

The failure of each bank seems to be based on poor judgement by the management. Both sets of executives are responsible for allowing the global liquidity crisis to bring each organisation to the edge of extinction. Businesses fail. That is the nature of capitalism. Indeed without failure there would be no risk. Innovation, flair and a roster of fresh products would be denied to consumers if all risk was eliminated. However, moral hazard dictates that we should not save businesses today if this is only to encourage the next generation of business leaders to make ever more unwise business decisions.

To keep a failing bank afloat is in itself a massive risk. But it is one which is best taken by another financial institution prepared to buy, often at a rock bottom price, the badly-holed operation. If not then the bank goes to the wall – that is unless you have friends in high places in government who will embrace your operation and tell everyone that they will turn the business into profit with little difficulty. The arrogance of our government in suggesting that it can better manage Northern Rock through this crisis with fewer redundancies and less pain to the country at large than a well-resourced other bank, is unbelievable. Northern Rock has proved a black hole of vanishing money today and it will continue to be so tomorrow.

The Governor of the Bank of England, Mervyn King, is still standing side by side with the government over its decision to nationalise the Bank but we hear little of why he was not amenable to the proposal by Lloyds TSB to take over Northern Rock before the crisis became public in September last year. No doubt this would have required substantial Treasury guarantees, but almost certainly UK taxpayers would have been in a considerably more favourable position than they now find themselves.

Money is getting tighter despite the Federal Reserve’s decision to reduce the US interest rate to 2.25% directly following the Bear Stearns affair (remember the UK remember has a bank rate of 5.25% until 10 April). If another British banking institution finds itself in serious trouble soon then I believe the government has given itself little room for manoeuvre and the crisis will mean a financial earthquake for this country.

No longer is the problem one of liquidity alone. Instead the concern is one of solvency – the key question now is whether the loans that many of our banks propose making are being offered to reliable debtors.

Taxpayers are already having to foot the bill to bolster Northern Rock and its staff and customers. The shareholders are likely to have lost most of the value tied up in their investments and well-resourced shareholder groups are now likely to seek from the High Court compensation following the government’s mismanagement of this crisis. They are unlikely to succeed, but their pain will go on.

In the US JP Morgan may consider it has got itself a bargain and the Bear Stearns’ shareholders may feel umbrage at only getting $10 for each of their shares, but at least they have some compensation in return for their stock rather than years of chasing through the courts, assets being settled by administrators. And they can now at least invest in JP Morgan if they believe the bank has made a good decision. We here in the UK can just watch our money being pumped into the abyss which is the hidden finances of Northern Rock.

Today’s uncertainty in the financial markets is no short-term phenomenon. The value of Northern Rock will reduce in the coming months not increase. Any sale of its parts will be decidedly difficult in the months ahead and in the meantime the taxpayers will continue to subsidise its ongoing operations.

The US government showed with its enthusiasm to support the Bear Stearns deal that it understands the importance of keeping politics out of corporate financial deals as much as possible. It seems that our current government with its much vaunted and much repeated claims of stability hopes to beat off any problems from global recession by borrowing as much money as it can lay its hands on. The country faces rough times ahead and the government’s recent record on financial management does not inspire confidence.