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Panic is reality for Bear Stearns

Scott Jagow Mar 17, 2008


Scott Jagow: At the start of this year, the investment bank Bear Stearns was worth $20 billion. Last night, the bank was sold for $236 million. That’s $2 a share. JP Morgan Chase is the buyer.

It’s a stunning collapse for Bear Stearns, and it prompted the Federal Reserve to take emergency action last night. The Fed cut one of its interest rates called the discount rate. And said it would open direct lending to Wall Street banks this morning — a very unusual move.

The overseas markets weren’t that impressed. A big sell-off in Asia, which we’ll get to in a moment. First, more on Bear Stearns.

We’re joined by Diane Swonk, an economist in Chicago who’s been following this closely. Diane, $2 a share — how is that possible?

Diane Swonk: Well, the alternative was Bear Stearns, if they did not have a buyer, might have had to go under and go bankrupt. This way, they become a part of another company. Certainly there was some influence by the Fed saying “Get this deal done.” Bear Stearns lost a lot of money in this, but it’s that or zero.

Jagow: Well, this all happened very quickly. Bear was seemingly OK middle of last week. What happened?

Swonk: This is exactly the problem is it’s sort of a self-fulfilling prophecy where panic overtook the market. Even those people who believed in it couldn’t keep their money in Bear Stearns. They advised their clients to pull their money out of Bear Stearns just as a precautionary move. If you have enough people do that at once, you have what we call an old-fashioned run on the bank.

Jagow: But could this be a red flag that other Wall Street banks could be in trouble?

Swonk: Well actually, the Fed went into great lengths to say Bear Stearns was a unique case. And the reality was Bear Stearns was not in as much trouble as their punishment sort of suggested. Bear Stearns was not considered the nicest bank in town — when we had crises in the past, they didn’t step up to the plate. And so, you know, there were many people who sort of turned their back on Bear Stearns. That also exacerbated the case for Bear Stearns having such severe problems.

Jagow: But still, Diane, you have the former Fed chairman, Alan Greenspan, now saying this could be the worst financial crisis since the end of World War II. Seems like there is some substance here.

Swonk: Oh, there absolutely is substance. You know, panic is reality. And I think really the last couple of moves by the Fed, I don’t think they’re fully understood by the market yet. But we may look back and say this was a Fed that finally got from being behind the game to being on top of its game.

Jagow: But so far, as you said, the markets haven’t been soothed by this. What is it going to take?

Swonk: Well one, you know, time is what heals all wounds. And the Fed’s going to do more. We’re also likely to see a 1 percent cut in interest rates on Tuesday, and it’s not inconsequential. I mean those people who say it doesn’t matter, anyone who’s got a credit card rate that’s tied to the prime lending rate will see a reduction in their interest rates. That’s important.

Jagow: Diane Swonk, chief economist at Mesirow Financial. Thanks so much.

Swonk: Thank you.

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