Let’s start with the positive news. Things looked great for the first few minutes of trading because of better-than-expected February inflation data. The CPI and Core CPI were both flat – analysts were expecting a 0.3% rise in the CPI and a 0.2% rise in the Core CPI. The most surprising piece of data was that energy prices declined 0.5%. The CPI is now up 4.0% year-over-year and the Core CPI is up 2.3% year-over-year (Source: CNBC.com). I’m a little surprised this data was so tame…maybe the Fed was right when they said inflation would moderate. Regardless of this report, inflation is present and squeezing the consumer as well as many companies.
The day started off looking like we would finish the week on a positive note, but bad news complements of Bear Stearns changed things drastically. Earlier this week I mentioned investors were worried about Bear Stearns’ capital position, but these rumors were denied by the CEO. Today, however, it took an emergency bailout from the Federal Reserve Bank of
Many people are now worried about Bear Stearns’ future and whether or not other banks are experiencing similar problems. If you remember, Bear Stearns is the company that first revealed they were being hurt by the sub-prime mortgage mess in July 2007 when they had two hedge funds collapse that were invested in mortgage-backed securities. Many people thought this was an isolated incident only associated with Bear Stearns, but that turned out not to be the case. People are worried about banks’ liquidity and access to capital and if this issue is wide-spread, there will definitely be some bank (or bank-related) failures.
This move by the Fed to bailout Bear Stearns is quite unique because “the loan to Bear Stearns required a vote (which was unanimous) by the Fed's Board of Governors because the company isn't a bank…The central bank is taking on the credit risk from Bear Stearns’ collateral, lending the funds through JPMorgan Chase” (Source: Bloomberg.com). The Fed has no obligation to help a company like Bear Stearns and because they are providing capital this must be an extremely serious issue that could possibly have much larger ramifications on the financial system and
On Thursday, I discussed how traders were expecting the price of BSC to fall 50% and they were right. According to Bloomberg.com, “option traders [today] increased bets that Bear Stearns's survival is in doubt. Implied volatility, a measure of how much investors are paying to insure against further stock-price losses, surpassed 300 today…that's a level Ambac Financial Group Inc. and Thornburg Mortgage Inc. reached this year when their viability was questioned.” Also, the Fed funds futures indicate a 64% chance the benchmark rate will get cut by 100bp on Tuesday.
CNBC discussed a possible take-under of Bear Stearns in the very near future. Usually, when company A buys company B (current market price of $100), a take-over occurs, i.e. company A will pay $100+ (a premium “over” the current market price) for company B. However, since Bear Stearns is in such deep trouble, the potential buyer – maybe JPMorgan – will offer a price “under” the current market price.
To help alleviate the strain on the financial markets from this liquidity and credit crisis, Fed Chairman Ben Bernanke said “The Federal Reserve is strongly committed to fully employing our authority, expertise, and resources to help alleviate [borrowers'] distress.” He also outlined four new rules governing lending practices in this CNNMoney.com article.
In other news…
- Moody’s downgraded National City Corp’s and Washington Mutual’s credit rating and Standard & Poor’s downgraded Bear Stearns credit rating
- So far banks have written down $195B worth of assets
- Consumer confidence fell to 70.5, the lowest reading since Feb. 1992
- Bear Stearns was downgraded to “under perform” by Oppenheimer
- Boeing was upgraded to “over weight” by Morgan Stanley
- President Bush spoke and he opposed the proposal to spend billions of dollar to buy empty homes…he wants the market to fix itself
- Lehman Brothers obtained a $2B, 3-year credit line from 40 banks to help with its liquidity issues
- UBS wants to resume the sale of its Pain Webber brokerage firm division
- The VIX (index measuring volatility) hit 32, which suggests an up or down movement of 9.3% in the next 30 days (Source: Bloomberg.com)
All eyes will be on Bear Stearns (Monday) and Goldman Sachs (Tuesday) as they report earnings. No one really knows how these banks’ balance sheets look and these stocks have taken a huge hit this year. Tuesday, the Fed will meet to discuss interest rates and people are looking for at least a 75bp cut. Turmoil in the financial markets has reached a breaking point and before we can move forward there needs to be a major bank failure.
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