At five in the morning on Friday 14 March, Fed chairman Ben Bernanke, Tim Geithner, the president of the New York Federal Reserve Bank, and top US Treasury officials held a conference call that may have saved the global financial system.
The choice facing them was stark. The central bank, in its role of lender of last resort, had to decide whether to extend an unprecedented back-to-back loan to JPMorgan Chase that might buy time for a rescue of the crippled Bear Stearns.
Or they could countenance the bankruptcy of the fifth-largest investment bank on Wall Street, and try to cope with what Mr Bernanke – a careful practitioner of central bank understatement – said would have been "a chaotic unwinding of positions" that would have exerted "exceptional pressure" on a global financial structure already struggling with its biggest crisis of confidence in a generation.
In a packed hearing room on Capitol Hill yesterday, Mr Bernanke and Mr Geithner, as well as the chief executives of the two banks and Christopher Cox, head of the market watchdog Securities and Exchange Commission, provided the most detailed account yet of the frantic backstage negotiations that led to JPMorgan Chase taking over Bear Stearns for $2 a share (subsequently raised to $10), in surely the most dramatic 96 hours in the recent history of Wall Street.
According to Mr Geithner, the first signals of trouble were rumours that European financial institutions were refusing to trade with Bear. But in the days before the crisis, all seemed in order to regulators. Bear's capital and reserves were comfortably above required international norms. Then, on Thursday, 13 March, the storm broke.
The rumours became a flood. As US banks also stopped doing business with Bear, its liquidity pool plunged by $10bn (£5bn) in a day, in Mr Geithner's dry words to the Senate Banking Committee, "to levels that were not adequate to cover maturing obligations and funds that could be withdrawn freely". In other words, the venerable investment house was facing an old-fashioned, and lethal, run on the bank.
Alan Schwartz, the chief executive of Bear Stearns, told the committee that "people wanted to induce a panic", and the SEC chairman, Christopher Cox, said it was aware of allegations speculators with bets against Bear were trying to manipulate the market. "Your hopes will be, I think, met and exceeded with respect to the agency's response to these concerns," he told the Senators.
But while stunned executives railed against unfounded rumours, it was too late. That Thursday evening, after alerting the federal authorities to its predicament, Bear called JPMorgan Chase, which functioned as Bear's clearing bank, to inform it of the situation. Federal officials held hectic consultations too, after Bear told them the next morning it would have to file for bankruptcy protection. The SEC saw no alternative to bankruptcy, barring extraordinary emergency action.
In Washington and New York, officials worked through the night to find a solution. They came up with a $13bn overnight loan through the Fed's discount window to JPMorgan Chase, which would then lend the money on to Bear Stearns. In the 5am conference call, the deal was finalised.
But everyone knew it was only a stopgap. "The action was to allow us to get to the weekend," Mr Geithner recounted.
"Having bought a little time, the central bank could continue to seek a private-sector solution, or "continue work on containing the risk to financial markets in the event that no such solution proved possible."
Alas, the impact of the Fed's announcement early on 14 March was soon undone, as rating agencies downgraded Bear's creditworthiness. The flight of customers accelerated, making it all but certain Bear would not be able to open for business on the following Monday – in reality Sunday night US time, when Asian markets began the new week.
Though the stricken bank "very quickly" contacted a number of other US banks, Mr Geithner told the committee, it quickly became clear that only JPMorgan Chase was willing and able to offer a binding commitment to take over Bear and meet the latter's short-term obligations.
But on the morning of Sunday 16 March, the would-be rescuer itself began to get cold feet. Some of Bear's risks appeared even greater than JPMorgan Chase felt it could take on, without additional guarantees from the Fed. So the central bank set up its "Primary Dealer Credit Facility" in effect making the Fed a lender of last resort to investment banks, as well as commercial banks.
Under this arrangement, Mr Bernanke and his colleagues agreed to lend JPMorgan Chase $30bn, secured by Bear assets valued at the same amount. JPMorgan "could not and would not have assumed the substantial risks of acquiring Bear Stearns" without the Fed facility, the bank's chief executive, Jamie Dimon, told the committee.
The package was announced just before markets in Australia and the Far East opened for business on Monday 17 March. Disaster had been averted, and the Fed was repaid its $13bn overnight loan, plus $4m of interest – a crumb of solace perhaps for the US taxpayer, who ultimately is underwriting the operation.
But, as exchanges at yesterday's hearing made clear, the controversy is not over. Several senators were openly sceptical of Mr Bernanke's assurance that the Fed had "an excellent chance" of getting its $30bn back. And how had that $2 per share price been arrived at? Had the central bank pressed for a low price – a steal, many Bear shareholders angrily complain – in its desperation to get the deal through?
Mr Bernanke insisted the Fed was not involved in setting the price. "There were multiple opportunities for other firms to talk to Bear Stearns. We had no interest in the stock price," it was a "secondary" consideration. By the same token, the agreement was anything but a "bail-out" of Bear Stearns, as some critics have charged.
As for Bear Stearns, another senator wondered, could it have been saved if the Fed had extended its discount window facility earlier to investment banks as well? No, was the reply from Messrs Bernanke and Geithner, a few days before the crisis, Bear seemed sound enough. The crisis of confidence blew up too quickly.
Mr Schwartz, though, said if the facility had been available "I think it's highly, highly unlikely in my personal opinion that we'd be in the position that we find ourselves in today".
Finally, could there be a repeat? The assembled US officials were less than entirely reassuring. The whole situation, with its origins in the sub-prime mortgage crisis, "took a long time to build up and will take a long time to work though the system". Markets were now calmer, but "we can't say there won't be another problem".Reuse content