Is Fed Buying MBS Paper in Form of LLC For Bear Deal?
A: I lied, I must talk about macro today after reading this article over at Interfluidity, Steve Waldman's blog via Macro-Man's analysis of the fed sponsored deal for the Bear buyout. Its strange, every time I think I get a grasp on what is going on here, I later learn I have no clue! PLEASE, SOMEBODY STEP UP AND EXPLAIN TO ME IF THE FED REALLY IS BUYING UP TOXIC MORTGAGE BACK SECURITIES AT HIGHER PRICES?
This is mysterious and warrants a discussion. I'm not sure where to start to make it simplest for all of us to understand, so bear with me for a moment.
Steve Waldman delves into what is really going on with the fed sponsored deal for the buyout of Bear Stearns over at Interfluidity; what we thought was a loan, isn't a loan at all:
It is not a loan at all. The Fed and J.P. Morgan are creating an investment fund, to be managed by BlackRock. The money that the Fed and J.P. Morgan will provide is startup capital for the fund. All of it is referred to as "loans", but that's facile.Lets revisit that last paragrah. Macro Man discusses:The Fed's ownership stake will be $29 billion, ostensibly in the form of loans at "the primary credit rate, which currently is 2.5 percent and fluctuates with the discount rate". But, that is largely meaningless. If the investment company's assets turn out to be worth less than the principal and interest due the Fed, then the Fed's loan won't be repaid. If its assets appreciate, J.P. Morgan gets paid out, and the rest belongs to the Fed.
Essentially, the Fed will own this investment fund and the Bear portfolio outright. JPM's position is basically a call option on the fund's assets at $29B plus time-value whose value is capped at $1B plus time-value. (JPM is long a call option and short the same option at a higher strike price.)
The Fed can deny all it wants that it is considering purchasing mortgage-backed securities. That is the economic effect of this arrangement. The Fed is buying up mortgage-backed securities and other unspecified assets at "the value of the portfolio as marked to market by Bear Stearns on March 14, 2008."
Things just get curiouser and curiouser. Not only has JP Morgan managed to dig under the sofa cushions and find enough dimes to quadruple its bid for Bear Stearns....but the New York Fed has put its side of the deal (eg, the loans that guarantee some of the shite that Bear owns) into a SIV, of all things, to be managed by Blackrock. Sure, if things go belly up, JPM is on the hook.....for a whole $1 billion. Gee whillikers!There is fed statement disclosing the financial arrangement of JPMorgan Chases's Acquisition of Bear Stearns; here are the key terms that the above blogs are discussing:
The New York Fed loan and the JPMorgan Chase subordinated note will be made to a Delaware limited liability company (“LLC”) established for the purpose of holding the Bear Stearns assets.So, my question is: IS THE STRUCTURE OF THIS NEW LLC, SETUP BY THE FED & JPM, IN ESSENCE BUYING UP THE MURDEROUS MORTGAGE BACKED SECURITIES HELD ON THE BOOKS OF BEAR STEARNS?The New York Fed loan and the JPMorgan Chase subordinated note will be made to a Delaware limited liability company (“LLC”) established for the purpose of holding the Bear Stearns assets.
Repayment of the loans will begin on the second anniversary of the loan, unless the Reserve Bank determines to begin payments earlier. Payments from the liquidation of the assets in the LLC will be made in the following order (each category must be fully paid before proceeding to the next lower category):
* to pay the necessary operating expenses of the LLC incurred in managing and liquidating the assets as of the repayment date;
* to repay the entire $29 billion principal due to the New York Fed;
* to pay all interest due to the New York Fed on its loan;
* to repay the entire $1 billion subordinated note due to JPMorgan Chase;
* to pay all interest due to JPMorgan Chase on its subordinated note;
* to pay any other non-operating expenses of the LLC, if any.Any remaining funds resulting from the liquidation of the assets will be paid to the New York Fed.
If so, then this statement by 'a senior fed official' is not entirely true:
"The Federal Reserve is not involved in discussions with foreign central banks for coordinated buying of MBS,"Maybe there is no co-ordinated effort, but clearly the fed is taking some toxic paper on! Talk about moral hazard.
Comments (3)
the payment chain is fine as long as they can liquidate the assets at a higher price than paid.
Thats the thing, it doesn't state the price paid on March 14th in which Bear marked to market!
Posted by Noah | March 27, 2008 2:09 PM
Isn't this something like the RTC that was set up to clean up the S&L mess? I remember seeing Bill Siedman(sp?) regularly on t.v. giving progress reports on the progress the RTC was making liquidating the real assets it had taken possession of from the S&Ls. But in that case the funding was coming from the taxpayers and the final bill was at least $200b.
This looks like there is more risk built in to the structure with the parties being JPM, the Fed. and the taxpayers through a guarantee of some of the MBS. How balanced the risk is is far beyond me to figure out. But, as I say, it looks like there are three participants. It looks like the fed theoretically would be paid before JPM but it has a lot more at risk and may not get paid back in full. Then they would have underwritten the acquisition of Bear by JPM. If the fed doesnt' get paid in full, I suppose the taxpayers would be out too. But that's what happened with the S&L crisis.
Posted by Query1 | March 27, 2008 3:27 PM
That denial by the fed is a wider one relating to a rumor that there may be a combined intervention by fed and ecb to buy up the mortgage backed securities.
The denial as you point out does not recognize the buyout (disguised as an infinite loan) on behalf of JPM (and the other finance houses!!) already in progress.
If I was JPM I'd be wondering if I could mix the omelet a little before forking over the "bear stearns" waste as this is a 30b opportunity to get full face value for stuff that according to bloomberg may only return 40 cents on the dollar if kept and managed for a full 10 years. This would be highly illegal but the fed is already taking policy advice from their customers in their panic ...
Anyway whether or not taxpayer intervention was the only solution it is disgraceful to see the frantic spin by the fed as they try to prop up the illusion of a normally functioning free market.
Posted by Justin | March 27, 2008 5:17 PM