Most Americans believe that, whatever happens on Wall Street, the US is already in recession, writes Denis Stauntonin Washington
ON THEIR way to work in midtown Manhattan on Monday, Bear Stearns employees passed marching bands, pipers and Irish dancers preparing for New York's St Patrick's Day parade.
At the company's headquarters, however, the mood was funereal and the sorry end of Wall Street's fifth-biggest bank was summed up by a two-dollar bill someone had taped to the front door.
The sale of Bear Stearns to JPMorgan for $2 (€1.30) a share was more than just a humiliation for Bear's 14,000 employees - between them, they owned 30 per cent of the company's stock.
The staff received a further shock on Tuesday when JPMorgan announced that half of them would be laid off. Such concerns did little to blunt the welcome that greeted the bailout on Wall Street, perhaps because, as New York Democratic senator Chuck Schumer put it: "When you're looking into the abyss, you don't quibble over details."
Customers and clients had been moving cash out of Bear Stearns since the start of the year, forcing the bank to sell assets to cover the demands.
On the face of it, the bank had a healthy $395 billion (€256 billion) in assets at the end of 2007; the problem was that only $34 billion was in cash or cash equivalent.
Much of the rest was in mortgage-backed securities, which had become increasingly difficult to sell since the start of the sub-prime crisis last year. Last week, a number of major hedge funds moved their business from Bear Stearns to rivals Morgan Stanley and Goldman Sachs.
The moves triggered rumours that a "run on the bank" was imminent, forcing Bear's chief executive, Alan Schwarz, to make a public declaration last Wednesday that the bank had ample liquidity.
But unimpressed customers continued to pull out their money so that, by Thursday evening, the bank was down to its last $2 billion in cash.
Desperate for a lifeline, it reached out to JPMorgan for help and put in a call to the US Federal Reserve and the US Treasury, warning that Bear Stearns faced the prospect of filing for bankruptcy protection on Friday morning.
The crisis threatened to take on a bigger dimension because, at 7.30am last Friday, Bear Stearns would have to start paying back some of the billions of dollars in loans it had taken out on the repo market.
The repo market is a system that allows banks and securities firms to exchange short-term loans, usually overnight and backed by securities. A default by a major player in the repo market would have been unprecedented and could have triggered a crisis of confidence in the entire system.
New York Federal Reserve chairman Timothy Geithner and his staff worked through the night on Thursday, studying Bear's books and trying to work out how the situation could be salvaged.
At 5am on Friday, Geithner held a conference call with Federal Reserve chairman Ben Bernanke and US Treasury secretary Hank Paulson to consider whether the bank should be allowed to go under.
Two hours later, they agreed to lend Bear Stearns money for 28 days, using JPMorgan as a conduit and hoping that the markets would be reassured by the move.
The gambit had the opposite effect, fuelling fears of an imminent collapse and making lenders more cautious than ever.
On Friday afternoon, JP Morgan chief executive James Dimon set up 16 teams of bankers to investigate a possible acquisition of Bear Stearns.
Meanwhile, Fed staff moved into Bear's headquarters, insisting that a deal should be agreed before the Asian markets opened on Sunday evening New York time. "It was just clear that this franchise was going to unravel if the deal wasn't done by the end of the weekend," Paulson told the Wall Street Journal. The teams worked through the night on Friday and Saturday, poring over Bear's records to try to establish how great the risks were that JPMorgan would be inheriting.
By Sunday morning, JPMorgan concluded that, although it was willing to buy the ailing bank, it needed the Fed's help.
The Fed agreed to lend JPMorgan $30 billion to complete the deal, secured by Bear Stearns assets that are almost impossible to value.
Although Bear Stearns shareholders can reject the deal, JPMorgan cannot walk away from it. And even if the deal is rejected by shareholders, JPMorgan can buy 20 per cent of the bank's shares for $2 each, enabling it to block any alternative sale.
JPMorgan will also retain the option to buy Bear's headquarters building in Manhattan, regardless of any decision made by the shareholders.
The sale of Bear Stearns, along with aggressive interest rate cuts and the opening up to securities firms of Fed lending facilities normally only available to banks, helped to restore confidence on Wall Street this week.
Most analysts agree, however, that the subprime crisis and the fall in the US housing market that precipitated it still have a long way to go, and that Bear Stearns is unlikely to be the last high-profile victim. The effective collapse of the 85-year-old investment bank has precipitated the biggest expansion of the Fed's role since the Great Depression of the 1930s and has persuaded the Bush administration that the US government must play a bigger role to protect the broader economy from the impact of the credit crisis.
As home repossessions rise across the US and hundreds of thousands of subprime mortgages prepare to reset at higher rates, three out of four Americans believe that, whatever happens on Wall Street, the world's biggest economy has already entered a recession.
