J P Morgan is always willing to help

March 17, 2008

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During the American civil war, John Pierpont Morgan helpfully arranged a deal to buy U.S. rifles and sell them back to the federal government at a whacking personal profit. One hundred and fifty years later the firm founded by J P Morgan has arranged a monster deal acquiring Bear Stearns, aided by Federal money

Several weeks on, J.P. Morgan increases its initial offering for troubled Bear Stearns by 500% to 10$ a share.

I make no claims to being an expert in high finance (or even low finance). I rely on excellent sources of information and insight, but from time to time I find myself out there more as an outsider looking for unexpected parallels between contemporary business life and historical accounts.

It is in such a spirit that I offer an observation on this week’s monumental financial news. The historical aspect as told by Zinn [and summarised in wikipedia] in his quietly revolutionary account is that during the Civil war Morgan

was approached to finance the purchase of antiquated rifles being sold by the army for $3.50 each. Morgan’s partner re-machined them and sold the rifles back to the army for $22 each. The military knew it was buying back its own guns, so the so-called ‘scandal’ turned out to be more about government inefficiency than any chicanery by Morgan (who never even saw the guns and acted only as a lender). Morgan himself, like many wealthy persons, including future Democratic president Grover Cleveland, avoided military service by paying $300 for a substitute.

Back to the present day deal

If B-S had flopped, the entire banking system would have gone into meltdown. B-S credit assets had increasingly been seen as less credible and thus less credit-worthy.
Hence the fire-sale.

Rather than have them declare bankruptcy, the Fed engineered a plan to have JP Morgan “buy” Bear Stearns for $2 per share. A price of $2 per share means the market was too optimistic in the last 14 months when Bear’s stock fell from $169.33 in January 2007 to $30 per share as of Friday’s [March 14th 2008] close.

The Fed smoothed the way for the take-over by cutting its interest rates, and offering other guarantees for inter-bank lending. This is believed to be calming the process of what is becoming known as deleveraging in the globalised financial services industry.

I am reminded of the arms-length fashion in which European governments involve in institutions in the national interest. Specifically, the role of the German Federal States in the matter of Volkswagen effectively protects the company from foreign (i.e. non-German) take-over. EADS is not a state-owned institution, but is thoroughly dependent on wishes of the French and German governments. So much so that it affects the increasingly difficult working relationship between Sarcozy and Merkel.

The bigger picture: Canute reversed?

One financial commentator quoted in the Wall Street Journal suggested we are seeing a case of Canute in reverse. The Fed appears to be acting not by erecting flood defences against an advancing tide, but trying to put up barricades against a retreating one.

In a bear market, as asset prices fall, leverage is reduced. This causes lenders to ask for more collateral on existing loans, and borrowers to sell assets so as to reduce the need for such loans, and for additional collateral … The credit crisis is unfolding as we expected, but more slowly than anticipated, because of the actions taken by central banks (mainly the Fed) and the U.S. government to allay its effects. The wholesale socialization of credit has meant that government and central bank measures account for 70% of new credit since last summer…total credit losses of $1.4 trillion will cause a contraction in world GDP of 2.5 percentage points, or half the current rate of global growth. So the global economy will become a gray, dull world of semi-recession and sticky inflation that will last a long time. Without major policy blunders, however, it won’t be a 1930s-style depression.

Leadership Lessons for the Quick-sands

It is probably of minor significance that Bear Stearns has not shown signs of effective leadership of late. The departure of James Cayne had been seen as finding a scapegoat rather than solving a problem:

Cayne has been pilloried since in news reports as a chief executive more interested in golf outings and bridge tournaments than one working diligently to get his firm out of its problems.

tTaking the wider financial picture, the Canute image may be a suitable and chastening one for those crying for stronger leadership. By someone. By anyone.

Come on Hillary, Barack, John, what might you do differently?

An honest answer might be. ‘A bit here and there.’ Avoid foolish claims of a New Deal or any other relatively quick fix to rescue the world from the global financial quick-sands.

There is a case for transformational change efforts financially and politically. But when in a hole, the sensible course of action is stop digging. In quick-sands, wrongly applied energy just makes things worse.