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this podcast is brought to you by
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knowledge at Warton please visit
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knowledge. won. up.edu for more
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information the ongoing credit crisis in
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US financial markets has claimed a huge
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and high-profile victim Bear Sterns the
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Wall Street Investment Bank and
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securities brokerage firm after being
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slammed by what amounted to a run on the
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bank during the week of March 10th be
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Sterns was pushed to the brink of Bank
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repy and then acquired for $2 a share by
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JP Morgan Chase over the weekend Federal
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Reserve chairman Ben Bernan and treasury
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secretary Henry Paulson played an active
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role in the transaction largely because
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of the potential impact that a major
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bankruptcy might have on confidence in
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the financial markets that same day the
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Federal Reserve lowered interest rates
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as it did again on March 18th by 3/4 of
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a percentage Point as the credit crisis
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shows no signs of easing our other wall
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Street firms likely to follow bare
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Sterns into Oblivion will the federal
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reserve's efforts help to boost
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confidence in the financial system Among
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Us and international investors Finance
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Professor Jeremy seagull author of the
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feature for investors discussed these
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questions and more with knowledge award
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Professor seagull thanks for joining us
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happy to be here Steve well the FED just
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lowered the interest rate by 34 of a
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point what effect do you think that that
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will have yeah that was right in the
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middle of of expectations what I thought
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they would do
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um there were two dissents this time
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which is is quite a lot uh Charlie pler
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joined Richard friser from the Dallas
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fed Charlie pler is here from the
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Philadelphia fed I know him very well
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he's actually a student of mine at uh uh
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when I Tau at the University of Chicago
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um and uh what concerns me and and I on
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the whole I think what Bernan is doing
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is is very good he's being aggressive
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where he has to be uh but but as I
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mentioned last time in the podcast I I
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I'm concerned that the FED is not acting
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as concerned about inflation as it
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should it did in its statement
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acknowledge that there were inflationary
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pressures uh but it did not Elevate
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inflation as a problem equal to the uh
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problem of of growth and I think both of
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them are problems at the present time so
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we're going to have to see how that
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plays out and whether Commodities are
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going to continue their ride upward it
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was broken yesterday uh but uh without
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coming out strongly against inflation
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we're going to be watching those
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commodity prices that's going to be
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important if they go back down it's
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going to be all right but if they
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continue up it's it's a
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threat let's turn to the other big story
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that's been playing out this week uh why
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did be Sterns implode so quickly it's
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like a run in the bank uh we don't have
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runs on banks anymore because we have we
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have Deposit Insurance we had the FED
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explicitly standing behind all the
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deposits but basically what happens is
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rumors start your your you know your
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money isn't isn't good and then you know
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you lose Nothing by getting it out uh uh
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so you you you run to the bank and and
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get it out now in in this case it's not
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a bank in in a formal sense but it's
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lenders that have been lending um uh
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Bear Sterns money against their
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portfolio against their purchases and
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all of a sudden they were worried about
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whether they would be repaid because
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this is very short-term Landing they all
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yanked their lending uh and this caused
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a tremendous cash squeeze because they
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didn't have enough cash and and and
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that's when the real problem started was
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the weekend sale at $2 a share to JP
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Morgan Chase the right move for the
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markets that that surprised me um uh a
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lot a lot uh I wasn't uh when they
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announced on Friday that they uh that
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the Fed was giving a 30 billion doll U
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uh credit or or or guaranteed to P
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Morgan I thought that that was a good
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move they said that it was going to be
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28 days and I thought that they would
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auction take four weeks and and auction
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off uh uh Bear Sterns or or tell them to
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find other financing I mean that they
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didn't have to sell themselves uh I was
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I was very surprised that it was done so
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quickly and I'm and quite puzzled at it
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and um I don't know whether $2 is a is a
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is a good price I think there's going to
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be a lot of controversy about this issue
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uh going
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forward in terms of what in terms of the
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fact that the shareholders of Bear
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Sterns this is a stock that was selling
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at 160 less than a year ago even after
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all the problems were announced last
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Friday it closed at $30 a share No One
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dreamed that it should be two and to
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sell it out at two um uh you know next
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we get all the facts uh seems to me to
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be uh too extreme and and I don't
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understand why it had to be done so
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quickly maybe there will be information
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forthcoming about that maybe the
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management did think that they were
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bankrupt then rather sell it out at two
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rather than go through bankruptcy uh
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we'll have to see what the results are
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but it it it was a pretty shocking um
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price right what impact would a Bear
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Sterns bankruptcy have had on other
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financial
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institutions well you know you want to
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ask question is there much difference
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between $2 and and a bankruptcy uh I
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mean that's one reason why I I think
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that the 28 day loan that the the FED
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made last Friday was very appropriate in
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other words let let's give us time to to
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sort this out and make a uh you know a a
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a reasonable uh attempt at getting other
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financing find out what the assets are
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um and and and that's why it surprised
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me that a sale was pushed through so
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very very quickly here so I liked what
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the FED did on Friday I'm not quite
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certain about why it then uh had pushed
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through as the word has it an sort of an
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emergency um
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uh sale at at at a fire sale price right
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the timing was supposed to uh happen
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prior to the opening of the asan markets
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on on Monday correct right the
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interesting thing is that um the markets
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were actually going to be opening better
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uh if when they learned of the $2 price
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that that that panicked the market it
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wasn't uh that was a very bad piece of
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news um actually when they announced
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that they were cutting the discount rate
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uh as they did before the markets open
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good move when they announced the sale
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when they heard the word sale good move
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and then they announced the price $2 and
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bang everything fell apart so it was the
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price uh more than anything else that uh
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that shocked the market I certainly
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support the move of lowering the
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discount rate as they did a quarter a
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point um is is is Layman Brothers
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vulnerable um certainly when you looked
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at the market yesterday uh they were it
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it sold as low as 20 now today a lot of
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confidence come back and selling at 40
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um I think they're I they are vulnerable
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everyone is quote vulnerable to a
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certain extent of a run uh however uh uh
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the financial status from everything we
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know about Lan is is far better than be
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Sterns bar stern was first of all far
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more involved in the mortgage back
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Market far levered I mean listen they
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thought this stuff was great they were
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buying it all the way down and uh with
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leverage and um uh although many Wall
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Street Banks ended up owning some of it
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they didn't keep on piling up it looked
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like a kind of a double down strategy on
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the part of Bear Sterns I mean look at
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this stuff is is is not worth as little
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the truth is had they had the liquidity
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uh to hold on um the be Stern's
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positions might have turned out to be
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very profitable just like long-term
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Capital Management 10 years ago had they
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been able to hold on uh those positions
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became profitable but um they weren't in
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both these institutions and um uh as a
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result without liquidity uh this this is
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this is a major risk you mentioned your
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surprised at the fed's move in all of
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this are are you uh what's your take on
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the fed's role uh it is it is it is
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playing a a proper role one has to
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realize when the when the Fed was was
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founded uh you know nearly 100 years ago
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um there was just the banking system I
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mean there really wasn't as much
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investment Banks and all the markets
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that we have today and and and
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everything else so all the lending
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functions were defined in terms of the
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banking system our financial system is
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so much bigger today I mean it covers i
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banks as well as commercial Banks and
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all sorts of markets uh that that did
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not really exist before so I think it is
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very proper for Bernan to now say let me
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extend credit to primary dealers they
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don't have to be dealing just with the
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commercial banks in other words we have
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to recognize the uh the um extensions of
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of the credit markets and the financial
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markets and I think that that he's doing
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so I think the as I say my at this point
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the only quibble I have with his policy
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uh is not coming out a little stronger
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on I'm worried about uh inflation
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because I think this is what's driving
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commodity prices and the dollar all his
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other moves I think have been very well
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thought of and uh certainly even the
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declines and interest rates if he had
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put a sufficient caveat on that I think
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I would I would uh approve of that also
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um uh on the whole though the FED is
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doing really just about everything in
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its power now to to keep the situation
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from uh developing worse and you know
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people say can get any worse when we
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look at the effects on the real economy
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so far um uh yes home prices are falling
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yes the home building industry is has
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turned negative as it has for the last
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year uh the amazing thing is is that the
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best estimate of Economist is that GDP
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growth in this first quarter just like
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the fourth quarter of of last year will
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again be positive and as we know
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unemployment rate has just ticked up a
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few T of 1% there has been um out a
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tremendous
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uh disturbances um and turmoil in the
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financial and credit markets but in the
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real economy um at this particular point
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we would have to say uh the effects are
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relatively mild okay what about the
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issue of moral hazard some critics have
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said that the FED inserting themselves
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in this situation other words yeah and I
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think one thing Steve and I I I think we
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all heard that as we're listening on on
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news
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reports this was not a bailout um
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by the FED I mean when the price of the
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stock goes down
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99% virtually wiping out every uh share
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uh owner um and in fact I'm shocked they
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they did the price so low I really think
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the intrinsic work was was was probably
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a bit higher one-third of these were
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bears and employees that held the stock
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in one form or another I mean it the
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firm's Equity was virtually uh was
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virtually wiped out so I mean uh you
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know the people say always this is
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encouraging this type of behavior before
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you wipe out 99% of the value that's not
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going to encourage uh that sort of
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behavior for it also one has to realize
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that this was actually a loan to JP
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Morgan um uh uh and they are intending
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to unwind that loan my prediction is by
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the way that the FED will not take any
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loss on those guarantees because I think
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when uh you know when everything is
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sorted out there will be enough to cover
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that and there won't be any loss and so
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I I don't believe believe that this will
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encourage similar if they had you know
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said we're buying out a Bear Sterns at
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you know $100 a share that would be a
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whole different but not at $2 a year so
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they're not laying out a safety net
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there is really no safety wet I mean
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basically uh you know Bear Sterns went
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all the way down it just didn't
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technically go into the bankruptcy right
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right are the the recent interest rate
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Cuts likely to restore confidence in the
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financial markets do that's more than
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just the interest rate Cuts it's all
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these actions to extend credit beyond
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the uh traditional Commercial Banking
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areas into other Financial uh areas um
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and and the process of lowering it my
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feeling is that we're going to get
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through this and I think that the FED uh
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you know by late summer will emerg as
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wow it went through a really difficult
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time and saved the economy maybe not
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from a recession but from something much
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worse and we know what it could have
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been because the 19 30s were a similar
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sort of situation um but the FED did not
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stand behind the financial institutions
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and then they were Banks let them all
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fail and we had the the worst economy in
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history uh I I think when we look back
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we'll say we he put everything he could
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reasonably at it um and um we're going
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to have a maybe a mild recession but
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we're going to avoid anything worse and
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uh we banki may very well easily turn
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out to be a hero here um when when
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everything is said and done and the
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recovery comes if not a recession are we
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likely to have a longer and deeper
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slowdown than we've had at least in
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recent times well you know actually the
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interesting thing is that slowdowns have
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been a little longer but much
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shallower um the Deep downward Spike
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that we used to get like particularly in
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manufacturing you know suddenly down and
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then up spikes of unemployment have
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given way in a more service oriented
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economy and in uh in in a slower a much
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more muted behavior of of unemployment
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and employment and and a a little longer
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in other words remember the sluggishness
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coming out of the 2001 recession uh you
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know prompted Greenspan to keep rates
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down for a long period of time um uh so
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my feeling is we may not pick up until
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2009 although I think 2008 might
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surprise us in the second second half
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but uh I certainly think it's going to
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be a very very mild recession if we do
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have one what are the implications for
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international markets well uh the the
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the the falling dollar is is a concern I
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voiced that uh at our last podcast that
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um I I worry that the International
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Community has uh not lost faith in in
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the Federal Reserve or in benan in terms
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of fighting the down term but in terms
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of fighting uh the uh inflation um and
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giving up on the uh International value
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of the dollar and I think that that's
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driving I mean since we talked you know
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a couple weeks ago the dollar has gone
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down even much further commodity prices
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have risen more oil is now you know back
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at 110 and going higher that is my my
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primary concern I think personally that
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is a bigger concern than you know Bear
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Sterns and the others those hit the
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headlines but you know what is happening
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to the dollar what's happening commodity
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prices um has has deep meaning in there
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and I'm afraid it's just going to give
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upward a pop of inflation which means
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that Bernan will then have to uh turn
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back from these cuts and in fact raise
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rates uh later on so if he comes against
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inflation now I don't think you would
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have to raise rates as much later on if
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he voices his concern he can break the
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commodity bubble and um and uh and save
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higher rates later on at this particular
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juncture I'm waiting for the market I
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mean we just got these Cuts uh you know
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today we'll see what happens on the
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commodi markets but if they continue to
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rise and the dollar continues to fall um
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uh Bernan is going to have to say we we
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uh we we now don't believe any more cuts
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are are needed or or desirable for our
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economy so Professor seagull what should
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investors be thinking about doing now
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well you know it's interesting in terms
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of uh you know when should you sell
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Market's gone down a little bit since
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then we've had a you know very good day
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today so far
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um one thing that I look at is Market
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sentiment um and uh we we've had I won't
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go into the details but we had some
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indicators that were very very negative
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um on the part of individual investors
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and newsletters and that is a contrary
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indicator in the sense that when
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everyone gets barrass and everyone
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throws in the town of the you know it's
00:16:51
it's just horrible that's usually where
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the market turns around and I'm
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beginning to see a lot of that negative
00:16:56
sentiment move into the market I'm
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seeing spikes of of of volatility I'm
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seeing um uh all sorts of indices
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flashing high anxiety and those indices
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are are are pretty reliable at bottoms
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uh in terms of of picking it I won't say
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we're at the bottom right now I think
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we're very close to the bottom uh don't
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get scared and sell anything out this is
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not going to be a Great Depression I
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know some people are talking about it um
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but uh if you see the way the FED is
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moving and making sure liquidity is in
00:17:27
the system when you look at what
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happening in the real economy and
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believe it or not it's still moving
00:17:32
along with very few people n have lost
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their jobs I think you'll see that
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there's a lot of reason to be confident
00:17:38
about the future thanks very much for
00:17:40
joining us today thanks for having
00:17:44
me for more information please visit
00:17:46
knowledge. won. up.edu
00:17:50
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