The assets that the Federal Reserve agreed to take from Bear Stearns in March to enable its sale to JPMorgan Chase have already dropped in value by $1 billion, the central bank announced.
The assets, mostly mortgage-backed securities, totaled $28.9 billion as of June 26, down from $30 billion at the time of Bear’s rescue in mid-March.
The original valuation of the assets, which don’t include subprime mortgages, came from Bear Stearns, while the revision came from the Fed and its advisor, BlackRock. The Fed intends to update the portfolio’s value quarterly.
The loss so far wouldn’t cost tax payers anything. That’s because JPMorgan agreed to cover the first $1.15 billion of any losses on the sale of the assets.
Moreover, given that none of the assets have been sold yet, any losses now exist only on paper. The Fed is expected to sell the assets over a period of 10 years, hoping to avoid any losses or market disruption.
Fed Chairman Ben Bernanke says BlackRock is “reasonably confident that we will be able to recover the full amount if we dispose of these assets on a measured basis, rather than to sell them all at once,” according to The Wall Street Journal.
The Fed may even earn a profit on the sales, Bernanke says.
But some on Capitol Hill haven’t been so sanguine. “What it looks like…is that we’ve socialized risk, and we’ve privatized reward,” Senate Banking Committee Chairman Christopher Dodd (D-Conn.) said at an April hearing, The Journal notes.
“We’re on the hook. Hopefully it doesn’t happen, but we’re on the hook.”
The Fed originally agreed to make the loan in March, because JPMorgan said without such a loan it was unwilling to take over Bear Stearns.
The Fed claimed it bailed out the fifth largest securities firm because had it not, then Bear Stearns would have been insolvent, and that would have created financial havoc in the broader financial markets.
And since Bear was a counter party to trades with notional values in the trillions of dollars, liquidation of the securities firm could have triggered a complete meltdown in the global financial system.
A newly created firm named Maiden Lane LLC was designated to hold the assets and finance a loan (Maiden Lane is a street near the New York Federal Reserve Bank headquarters in Manhattan). JPMorgan supplied $1.15 billion, which would cover the first losses from any decline in the assets' value.
The Fed and BlackRock are valuing the portfolio in accordance with accounting guidelines that call for an estimate based on sales in an “orderly market,”' rather than a hypothetical forced liquidation. The value doesn't necessarily reflect what the securities would fetch if Maiden Lane tried to sell now.
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