WASHINGTON — The Federal Reserve and Treasury Department orchestrated the "fire sale" price for the quick purchase of investment bank Bear Stearns, the chief executive officers of the banks involved told Congress on Thursday, disagreeing with each other about whether such a rushed deal was necessary.
During a gripping five-hour hearing before the Senate Banking Committee, the CEOs of Bear Stearns and JP Morgan Chase gave their versions of events that led up to the government-brokered sale of the venerable bank March 16, with $29 billion in taxpayers' money at stake in the deal.
Bear Stearns CEO Andrew Schwartz and JP Morgan Chase CEO Jamie Dimon said that top U.S. government officials encouraged a low sale price — originally $2 a share but later raised to $10 — to avoid rewarding investors who'd made a bad bet.
They said that Timothy Geithner, the president of the Federal Reserve Bank of New York, and Treasury Secretary Henry Paulson knew of the price being discussed and that both pressed for a deal that didn't bail out investors who'd gotten themselves in trouble.
Schwartz and Dimon painted very different pictures of how the unprecedented government-brokered sale came to be.
They agreed on this much: As recently as the first week of March, Bear Stearns had access to $21 billion in capital. As investors withdrew money and partners shunned the firm, however, that total slipped to $12.4 billion a week later.
On March 13, the wheels came off. By day's end, Bear Stearns was left with just $2 billion in accessible capital.
"People hadn't appreciated the extent to which these nonbank institutions perform the functions of banks and were susceptible to bank runs," Jeffrey Gordon, a law professor at Columbia University in New York, said in an interview. "The relevant players have much quicker means of getting their money out than lining up outside the bank and waiting at the teller window."
JP Morgan Chase was already Bear Stearns' bank, and had previously worked out what Schwartz thought was a 28-day loan from the Fed to ensure its solvency. This loan, Schwartz said, may have been what sparked the run on Bear Stearns, because it was tailored to one specific Wall Street player, not all of them.
This, he suggested, put a bull's-eye on Bear Stearns, inciting the multitude of players on the other side of business deals with Bear Stearns to fear that its finances were worse than advertised.
However, Bear Stearns had been a concern to financial markets since last summer, when two of its hedge funds — pooled investment funds for the very wealthy — collapsed. The Wall Street Journal reported in November that Bear's then-CEO, Jimmy Cayne, was off playing bridge last August while other Wall Street executives tried to stop the unfolding turmoil that now envelops financial markets.
On another matter that's now in dispute, Schwartz testified that there were other financial players who might have been willing to pay more for Bear Stearns, but the Fed forced a quick sale.
"I think all of the leverage went out the window when a deal had to happen over the weekend" before Asian markets opened for trading, he said.
Dimon disputed that there was interest from other financiers, and defended the low sales price as well as his own demand that taxpayers' money be put at stake too.
"We had literally 48 hours to do what normally takes a month," he said of the unusual deal, in which the Fed put up $29 billion in a loan that accepted some risky assets as collateral, including mortgage bonds that are precisely what roils Wall Street today.
Underscoring the deal's haste, New York Fed President Geithner told lawmakers Thursday that although it's receiving advice on the deal from Blackrock Financial Management, no price has been agreed to yet for services being rendered.
"Almost nothing is typical about the agreement," he acknowledged.
Some experts see a dangerous precedent in the deal.
"Everybody is making money except the taxpayer," said Yakov Amihud, a finance professor at New York University. He said that Bear Stearns shareholders avoided complete losses and JP Morgan Chase saw the value of its outstanding stock rise by $19 million soon after the deal was announced. "I think what happened is they (the Fed) got panicked and they started to throw taxpayers' money around."
Federal regulators testified Thursday that they indeed were concerned and had acted swiftly to prevent runaway panic, which could shake both Wall Street and Main Street.
"For the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured financing, but short-term secured financing," said Christopher Cox, the head of the Securities and Exchange Commission. Bear Stearns couldn't borrow, no matter what it offered as collateral.
Fed Chairman Ben Bernanke testified that standing by wasn't an option.
"The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence," he said, suggesting that a market collapse could have ensued. "The company's failure could have also cast doubt on the financial position of some of Bear Stearns' thousands of counterparties" — parties it does business with — "and perhaps of companies with similar businesses."
He added that "given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain."
The action was accompanied by an equally unprecedented decision by the Fed to provide emergency short-term lending to major investment banks that it doesn't regulate directly.
"If you want to say we bailed out the market in general, I guess that is true," Bernanke testified, saying that he did so in the interest of the U.S. economy.
Gordon, the Columbia law professor, said government officials shouldn't be faulted for not anticipating the Bear Stearns meltdown:
"Who is going to predict with any reliability an unprecedented event? It's not realistic. The key question is not that they failed to anticipate it."
He said the key question was what steps they'd take to prevent further surprises and that the Fed had answered that by broadly expanding credit.
ON THE WEB
Alan Schwartz's opening statement.
Timothy Geithner's opening statement. Jamie Dimon's opening statement.
Christopher Cox's opening statement. Ben Bernanke's opening statement.
The Fed's contract with Blackrock.