America's Northern Rock
The rescue of Bear Stearns demonstrates that the worst of the global credit crunch is not yet behind us.
As an incident, it is America's Northern Rock.
But the run on Bear Stearns hasn't been a run of small savers, as happened at the Rock.
There has been a wholesale run on this leading investment bank, a withdrawal of capital by leading financial institutions.
Bear Stearn's creditors have become progressively concerned about Bear's exposure to mortgages - not subprime mortgages but AAA good-quality home-loans.
Why? Because on a daily basis there's been more and more disturbing news about the deterioration in the US housing market and the difficulties faced by borrowers in repaying their debts.
This is what did for Carlyle Capital Corporation earlier this week. And it meant that in just the last 24 hours Bear Stearns came close to running out of the cash or liquidity it needs to meet its daily requirements.
So enter the New York Federal Reserve. It is promising to supply whatever liquidity is required by JP Morgan Chase, the leading bank, to help Morgan provide whatever funds are required by Bear Stearns.
Since JP Morgan is saying there is no risk to its shareholders, this represents a central bank bailout of Bear Stearns
So, as I say, this is America's Northern Rock.
UPDATE 16:40: A bit of context on Bear Stearns.
First, please don’t overstate the analogy with Northern Rock. Bear Stearns is an investment bank at the heart of Wall Street. It is not a retail bank like the Rock.
Second, it is – like the Rock – what regulators classify as a high impact firm. Or to put it another way, it is too big to fail.
Why? Because its businesses had consolidated assets $395bn at the end of November 2007 – which would make it roughly twice the size of Northern Rock.
If it had gone down, and there had been a fire sale of assets, there would have been a double whammy for the financial system.
First, there would have been losses for those institutions and individuals that have provided $383bn of credit to the various bits of Bear Stearns (there was also $12bn of equity supporting all that debt).
Second, the market price of all sorts of financial assets would have collapsed. And that could have caused solvency and liquidity problems at other banks and financial institutions.
So the New York Fed had no choice but to rescue Bear Stearns.
What’s unclear is whether the main problem at Bear Stearns is – like it was at the Rock – mainly one of technical insolvency caused by an inability to raise finance.
Or whether there is already a deficit between the value of Bear Stearns’ assets and its liabilities.
The trigger for the rescue of Bear Stearns was that the liability side of its balance sheet has gone wrong; it is in danger of running out of cash to fund itself.
But are its assets of reasonable quality?
As of November 30, it had $46bn of exposure to mortgages. And it is a fall in the market-value of mortgage-backed securities that has spooked Bear Stearns’s creditors.
The big question is whether creditors’ anxiety is hysterical or rational.