Bear Stearns Shock Crosses the Atlantic

As worldwide markets reel on the news of JPMorgan's buyout, the big question is: How many other banking institutions are on the verge of collapse?

by Stanley Reed

The Federal Reserve most likely did the right thing when it backed JPMorgan Chase's (JPM) purchase of Bear Stearns (BSC) on Mar. 16. But the sudden collapse of a well-known Wall Street firm and the penny stock, $2-per-share price that JPMorgan is paying—less than 10% of Bear's already battered market cap on Mar. 14—rattled European and Asian markets on Mar. 17.

If Bear is close to worthless, the thinking goes, what does that mean for other troubled institutions in Europe, the U.S., and elsewhere? Can other failures be far behind? A wide range of European banking shares, including UBS (UBS), which has been hit hard by subprime writedowns, Royal Bank of Scotland (RBS), whose capital base has been stretched by the ABN Amro takeover, and smaller British banks such as Alliance & Leicester (ALLL.L), took a pounding on Mar. 17.

More Bad News for the Dollar

Bear, which like many banks depended on outside financing, had to be rescued because its creditors lost confidence and cut off their funding. The same could happen to other banks. Unlike industrial companies, which can continue functioning despite being under pressure (or even in bankruptcy), "Banks are either creditworthy, and have a business; or are not worth lending to, and do not," according to a recent Morgan Stanley (MS) note by Laurence Mutkin, who worries that "more financial institutions will need official support," unless their funding costs ease.

The Fed's move to put up $30 billion in guarantees for Bear—and its open-ended commitment to tide other U.S. institutions through the current liquidity crisis—also proved to be more bad news for the beleaguered dollar. Investors continue to flee to the euro and the Swiss franc, both of which hit record highs on Mar. 17, because at this point it looks like the only way out of the crisis is to print more greenbacks. The euro climbed past $1.59 before settling down to $1.573 at day's end. The Swiss franc rose to more than $1 in value.

But the dollar sell-off wasn't universal. For instance, the British pound declined against the dollar. Investors are coming to see Britain as a country with problems similar to those of the U.S.—overpriced real estate and overstretched banks. To make things worse, the Bank of England has been behind the curve in recognizing the seriousness of the global financial problems. It did agree to add $10 billion to the banking system on Mar. 17.

The dollar's slide against oil and other commodities also stopped, at least temporarily, with oil falling about 5% agains the dollar to $104.60 per barrel as of midday on Mar. 17 as investors worried about a slowdown in the global economy.

Still, the chaotic market conditions show there is a real possibility now of the long-dreaded meltdown of the dollar that could destabilize world markets. For that reason there is talk of coordinated global intervention to stabilize the currency. But there are few concrete signs yet of a meeting of the minds of central banks and governments. To be effective, coordinated intervention would likely require action by the Fed, the European Central Bank, the Bank of Japan, and other G-7 banks, as well as, possibly, action by some of the big emerging-markets players such as China and Saudi Arabia.

When Funding Costs Too Much

A more immediate concern than the swooning of the dollar is the general sickness in the banking system, which the Fed is trying to address. Bear provides a stark example of what can happen to a bank when its creditors turn off the tap. Its demise was reminiscent of the collapse of mortgage lender Northern Rock (NRK.L) in Britain last summer and fall—though the Fed was far more decisive than the dithering British authorities, who ended up having to nationalize the bank.