Liquidity Won't Fend Off Cannibal Banks

Commentary by Mark Gilbert

April 3 (Bloomberg) -- U.S. and U.K. regulators are wasting their time threatening traders who profit from speculation about the deteriorating health of the financial community. The gossips aren't to blame for the demise of Bear Stearns Cos., and they won't be at fault when the next firm goes bang, either.

Brokers, futures traders, collateral managers and compliance officers are ranking their counterparties from strongest to weakest, and choosing to stop doing business with whichever company comes bottom. If the same name gets crossed out on every list, it spells game over for the loser -- deserved or not.

The Federal Reserve's decision to fund the shotgun nuptials between JPMorgan Chase & Co. and Bear Stearns to the tune of $29 billion is as puzzling as it is troubling. What right did the U.S. central bank have to arrange a private sale? Why wasn't there a collective Wall Street solution? And why didn't any competitors challenge JPMorgan's status as sole buyer?

If Bear Stearns was such a bargain at the initial bid of about $2 -- real-estate agents valued its 45-story Manhattan headquarters at six times more than JPMorgan was shelling out for the entire firm -- where was the line of competing suitors hammering on the Fed's windows offering pricier dowries of $3, or $4, or $5?

Even at the revised cost of about $10 a share, analysts are applauding the deal-making prowess of JPMorgan Chief Executive Officer Jamie Dimon, even though none of his peers seems inclined to offer the Bear Stearns shareholders and employees an alternative path to salvation.

`Off The Table'

The Fed's decision last month to expand the list of firms it is willing to lend to ``takes the liquidity issue for the entire industry off the table,'' Richard Fuld, CEO of Lehman Brothers Holdings Inc., said on March 17.

Really? If liquidity is no longer a concern, why did Lehman need to raise $4 billion in a stock sale this week? Why is UBS AG planning to tap its shareholders for a cash infusion of 15 billion Swiss francs ($14.8 billion), in addition to the 13 billion francs it already snagged from investors in Singapore and the Middle East?

Banks can protest all they like about how secure their access to funds is on a given day; recent events have shown just how fast confidence and liquidity can evaporate. Fed Chairman Ben Bernanke said yesterday that ``the financing we did for Bear Stearns is a one-time event. It's never happened before and I hope it never happens again.''

Banks Smell Blood

Investigating who was spreading speculation to bet on a share-price decline is pointless. Why wouldn't you sell shares of New York-based Lehman or Edinburgh-based HBOS Plc, after seeing how swiftly the banking system can turn cannibal when it smells blood?

The origins of the current market crisis can be traced back to last year, when two Bear Stearns hedge funds blew up. Requests for help fell on deaf ears, with Merrill seizing $850 million of bonds that were collateral for money it had lent to the funds.

Enlightened self-interest suggested that the lenders should quietly prop up the funds. Instead, the fire sales of distressed securities meant investors started to realize for the first time that values in the market didn't match the grades assigned by the rating companies.

The seeds of the downfall of Bear Stearns, though, may have been sown a decade earlier. In his 2001 book ``When Genius Failed,'' Roger Lowenstein details the Fed's crucial 1998 meeting to convince Wall Street that it should shoulder the financial burden of keeping Long-Term Capital Management LP afloat or risk financial meltdown.

Paragons of Enterprise

James Cayne, the CEO of Bear Stearns, told his peers -- including Philip Purcell of Morgan Stanley and Herbert Allison of Merrill Lynch -- that his company wouldn't join the 14 securities firms paying for the rescue.

``In unison, the CEOs demanded an explanation,'' Lowenstein writes. ``This only made Cayne more resolute. Bear had enough exposure as a clearing agent, Cayne said. He wouldn't say more. Suddenly these paragons of individual enterprise seethed with communitarian fervor. Purcell of Morgan Stanley turned beet red. He fumed, `It's not acceptable that a major Wall Street firm isn't participating!' It was as if Bear were breaking a silent code; it would pay a price in the future, Allison vowed.''

If the LTCM debacle was happening today, recent experience suggests the Fed would have to use taxpayers' money to shore up the system. Wall Street currently prefers cannibalism to cooperation -- remember the failure of the Super-SIV plan?

$19 Billion Writedown

Equity investors have taken heart this week from the capital-raising plans of Lehman and UBS, as well as the latter's $19 billion writedown of the value of its debt securities. Once again, they are falling for the falsehood that the bad news is behind us. Only two days ago, Deutsche Bank AG said ``conditions have become significantly more challenging during the last few weeks.''

Banks are engaged in a beggar-thy-neighbor fight for survival. The correct number of banks to go bust in a crisis isn't zero, and it probably isn't one, either. As Suffolk, Virginia-based economist Dennis Gartman is fond of reminding readers of his newsletter, there is never only one cockroach.