03 04 08 Insolvent or Illiquid?
This headline just crossed the tape: DJN: *DJ Bear's Schwartz: Bank Run Prompted By Unfounded Rumors. Really. Given the significant suspicions behind the moves by the Fed to have JPM take over BSC (as well as take onto its own books $29B in mortgage related assets) it is time for the Fed, BSC and JPM to answer the simple question: What caused BSC to fail over that weekend? Simultaneous to the announcement of JPM taking over BSC, the Fed announced a new lending facility open to all primary dealers, of which BSC was one.CEO Schwartz would like us to believe that BSC was simply illiquid - that they could not raise funds by repo or credit lines or any other means as the counterparts were refusing their name. If that is so, why was the new Fed facility either (a) not available to BSC and/or (b) not sufficiently large to fund BSC until they were able to re-establish their credit worthiness in the market place, either by audit or additional capital injection?
Or was it the case that upon review, the Fed decided that BSC was not just illiquid but that they were for all intents, insolvent too and that any 'value' in the firm - 'goodwill' and the possible excess of assets over liabilities - could not be quickly realized and were not material in light of the size of BSC's balance sheet and funding requirements. In fact, most commentators when speaking of a valuation on BSC placed most of the value on its real estate and the good will of a few specific subunits. There is likely value, though hard to quantify, in the intellectual property of BSC.
We would have preferred to see Wall Street handle the demise of BSC on its own, perhaps with some strong arming by the Fed and Treasury department as happened with LTCM. Had the 'crisis' continued another few days it is likely some solution could have been found, perhaps involving group ownership through a holding company by a large number of banks and brokers thus limiting individual risk while preventing the wholesale liquidation of the assets of BSC.
However, the Fed did what it clearly thought was most prudent at that moment in time. But they have not answered the important question of illiquidity or insolvency. If BSC was simply illiquid then the Fed has gone well out of bounds by picking a winner and loser and forcing the sale of BSC to JPM while offering cash flow to others. The American people and the financial markets in particular, need to know the real answer.
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