Too Big To Fail

6 June 2016

Jamie Dimon, CEO, of JP Morgan Chase, attended an emergency meeting at the Federal Reserve Bank of New York on September 17, 2008. A dozen CEOs from rival firms were present-the meeting’s goal was to devise a plan to save Lehman Brothers, the nation’s fourth largest investment bank, from bankruptcy. Dimon knew Merrill Lynch and AIG were also in trouble.

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Many present at the meeting thought the government would step in and rescue Lehman Brothers.

Dimon held a conference call with his top management team and said to prepare for a filing not just of Lehman Brothers, but also for Merrill Lynch, AIG, Morgan Stanley, and possibly Goldman Sachs. Fear and disorder gripped the market-the financial sector seemed to unravel. Yet, in 2007 the financial services sector accounted for more than 40% of corporate profits. The mortgage industry was an important piece of the sector. Mortgage loans served as components for complicated financial products that Wall Street bought and sold. People knew that Goldman Sach’s was going to go under. It would be bad and becomes the Great Depression.

In 2007, those working in the financial sector received compensation in the aggregate worth 53 billion. The CEO of Goldman Sachs, Loyld Blankfein, took home 68 million. Wall Street used a lot of debt to finance its activities. There was cheap money from savings glut in Asia and ease in Fed Policy in response to the 2001 recession. Cheap money found its way into the subprime mortgage market-Wall Street firms believe they had a way to slice up mortgage loans and sell them, thereby removing a log of the risk off their balance sheets. They also bought a lot of mortgage back securities from each other. Bank gave out loans but know they couldn’t pay back.

People claiming they were making lots of money but it wasn’t true.

Bernanke believe in April 2007 that problems in the subprime mortgage market could be contained. By August 2007 in the $2 trillion subprime mortgage market collapsed. Two Bear Stearns Hedge funds that bet on subprime mortgages lost $1.7 billion in investors’ funds. There was difficulty finding a price for these mortgage securities because no one wanted them. The market just wasn’t working. People thought they were toxic.

Richard Fuld, CEO of Lehman Brothers is called back from a business trip to India by the Treasury Secretary, Hank Paulson. He was told that Bear Stearns, fifth largest investment bank was being sold to JP Morgan Chase for $2.00 a share, and that the fed had agreed to take up to $30 billion of losses on the worst assets of Bear Stearns in order for Jamie Dimon to agree to the deal that averted bankruptcy for Bear Stearns. Run on the Bank

– An old fashioned run on the bank seen in 1930s – investors/customers lose trust that their money is safe. They all want it back at the same time. Hedge funds played a big role.
They had liquidity crisis.

Investors React
– In response to the Bear Stearns merger, Lehman Brothers shares were down 21%. Fuld personally had lost on paper $89.5 million. – Treasury Secretary Paulson called to find out if Lehman Brothers was losing trading partners.

Lehman is next?
– Rumors swirled that hedge funds were taking their money out of Lehman, and banks were refusing loans to Lehman. – Lehman had to watch for a self-fulfilling crisis based on rumors about its liquidity. – Fuld and his staff gave interviews…………………

Pitching the Book
– Erin Callan, CFO of Lehman Brothers held a conference call, went through Lehman’snumbers and the consensus changed-Lehman would survive.

Short Sellers Strike Hard
– Not everyone was buying the story, David Einhorn, a well known hedge fund manager, commented that “Lehman was a house of cards.”

Bear Stearns Shareholders
– Jamie Dimon agreed to raise the price paid for Bear Stearns from $2.00 a share to $10.00 a share, afraid that shareholders would vote down the merger for #2.00 a share. – If the shareholders voted down the deal, JP Morgan Chase would still have to guarantee its trades for a year.

Leave it Alone
– The package was criticized by both Democrats and Republicans. – Conservatives believed the market would take care of itself and government intervention would make matters worse.

Raise Capital
– Treasury Secretary, Paulson, came from Goldman Sachs and held the view that Lehman just was not as good as Goldman. – He wanted Lehman to raise capital, and thought Warren Buffet would be a good catch, would be a good housekeeping seal of approval.

Thumbs down from Buffet
– Buffet offered very expensive terms for an investment, and after looking over Lehman’s books wasn’t interested. – Another group of investors were.

We had to do it
– Under Senate questioning, the SEC, Treasury, and Fed officials argued that the rescue of Bear Stearns was a once in a lifetime deal that would not be repeated.

How Bad Will It Get?
– Paulson had a small team put together a “white paper” on what should be done if the financial system collapses. It was presented to Bernanke. – Bernanke was different in many ways from Greenspan.

Bernanke’s Pate is Full
– Greenspan believe in free markets.
– Bernanke was a scholar of the great Depression. Believed that the Fed had adopted policies that caused a recession to turn into a depression. The policy that would have worked was cheap money. Statue of limitations which is 5 years.

Why want to have a Great Depression?
He’s a scholar of Great Depression.
The Fed affected the Great Depression.
The Fed was needed in the Great Depression.
They felt there were enough liquidity and easy money.
Fed should apologize for the Great Depression and make sure it won’t happen again. The Fed had screw up and make sure it won’t happen again.
No deflation, don’t want it to happen.
When deflation gets in, it’s very hard to stop.

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