This is worse than LTCM because in order to provide backup to JP Morgan, the Fed has to use a depression-era provision to provide loans which they have not used since the great depression in 1930s, until now. So you know how much serious and important this crisis and bailout are compared to LTCM 10 years ago or S&L crisis 20 years ago.
The rumor of BSC running of cash was actually widely circled last week in the fixed income market, which forced BSC to make a public statement on Monday (3/10) to ensure the public that their financial situation was solid and their liquidity was sufficient. Were they? Well, for many Wall St. experienced veterans, who smelled more blood coming, this actually meant that BSC was in big trouble. Pretty soon, any trades involving BSC got reviewed, scrutinized, rewound and cancelled. Hedge funds, mutual funds, and capital management companies stopped using BSC brokerage service to execute their trades, existing customers tried to cash out their holdings and withdraw all their funds at BSC. This is a typical run on the bank like 1930s. At that time, the small and local banks were running out of cash due to withdrawal by farmers, which spread to large and national banks, then all the way to the Central Bank of the United States.
Bear Stearns is in a worse situation than LTCM in the sense that clients of hedge funds have many limitations to withdraw their capital, and they can not withdraw at the time they want, which buys hedge funds time to work out the liquidity issue. Also hedge funds can usually deny their withdrawal any time they want according to the legal contracts mutually agreed by both parties. This is why even a big crisis such as LTCM is easier to be contained, only dealing with a small number of elite investors (set aside the counterparty risk causing investment banks from LTCM derivatives). But in this case, BSC can not, because it is a bank, even an investment bank (thank God, not a commercial bank). This is why it requires Fed to step in and use rarely used means to resolve this bank run crisis. At crisis like this, any book value or asset evaluation becomes meaningless, only one thing counts: liquidity (cash).
This should not surprise Jeremy Grantham who is one of the most respected money managers in this country. In July 2007, before anyone had even heard the words of subprime, credit crisis, run on the bank, he boldly predicted the following (in his own words):
"In 5 years I expect that at least one major "bank" (broadly defined) will have failed and that up to half the hedge funds and a substantially percentage of the private equity firms in existence today will have simply ceased to exist". Maybe Bear Stearns will on Monday, so is Carlyle Capital. We will probably lose count after 5 years.
In July 2007, everything was looking so wonderful, blue sky way ahead, and Bernanke even said that the strong real estate market merely reflects the strong economy at that time. Sure, we took your word for it. Who would have listened let alone believed what Jeremy said? He maybe just a crazy old man out of his mind, who happens to be just old enough to remember the 1930s? Who would have thought that a perfect storm looming was just a month after he spoke? Talking about perfect timing! Almost no one, not even George Soros who said that this is the worst financial crisis in 60 years (he only said that recently after the fact) predicted this last year. Only Jeremy Grantham.
BSC is only the 5th largest US investment bank, relative small for Fed to rescue and for other banks such as JP Morgan to acquire. What happens if there is a 2nd one coming? This thing never happens alone and once. Fed would be running of funds and Wall St will be running out of large banks to rescue them. Fixed income market is in deep fear right now, for example, last Friday, spread of CDS (credit default swap) on Lehman Brothers has widen to 465 basis points, which is at the same level as Bear Stearns early this week. Even there could be a bear market rally coming in the banking sector, thanks to the Fed's rescue, this crisis is far from over. Previously it seemed like a slow moving train wreck in 5 years, as Jeremy said, but it certainly looks like the train is really speeding up during last couple months and more crashes coming ahead. This is only the early inning of this banking crisis. We just hope that BSC won't drag the whole banking industry to its knees. Yesterday (3/14/2008) will definitely be recorded in the history book for the banking industry.
By Thomas Tan, CFA : See his profile at Vestopia