When I woke up this morning, She was gone, solid gone

The title from the Younblood's song "Grizzly Bear" sums up Bear Stearns' liquidity situation this morning. Bear Stearns, a well respected and storied Wall Street firm was brought to the brink of collapse after its liquidity dried up.

Bear Stearns is a major player in the mortgage securities market. The firm is smaller than the other major Wall Street firms and does not have as diverse a business model as its larger and thus was more severely impacted by the down turn in the mortgage market.

Writedowns and reduced profits from its core business have negatively impacted Bear's earnings. Counterparty fears caused other market participants reluctant to trade with Bear. To make matters worse, Bear's creditors cut them off from further capital.

If Bear failed the repercussions around the street could be catastrophic. Bear, as with all other dealers and banks, finances trading positions in the repo market. If Bear failed, it could be some time before such repos were unwound. Money deposited with Bear could be locked up for some time until the situation could be sorted out. Trades would not have settled, leaving counteparties without their promised securities of cashed and other firms could have been pushed to the edge of disaster.


Since no private sources wished to loan Bear money, Bear would need to go to the Fed. The problem is that, except via the repo market, the Fed only lends directly to banks. Bear's clearing agent JP Morgan was called in by Bear for help. Bear CEO Jamie Dimon contacted NY Fed President Geithner and arranged financing. JPM will give Bear 28 day financing which is ultimately backed by the. With liquidity tight and other firms likely to have further writedowns and liquidity problems of their own. The Fed needed to prevent Bear from failing. Bear is now scrambling to find a partner to avoid an implosion.

This underscores the true problems in the financial markets. It is bad. This is why the Fed will risk a prolonged recession. If it let the banking / financial system fail, instead of a recession, we could have a depression.

As recently as last week, there were some strategists who said that the liquidity crisis was overblown and this is just like 1990. This weeks liquidity problems only emphasize just how foolish that analysis was.

Look for more poor earnings , writedowns, Fed easing and inflation for the balance of 2008.