The Fed's role in Bear Stearns

As loans go, the Federal Reserve's $29bn, to facilitate JPMorgan Chase's acquisition of Bear Stearns, is certainly unusual. Market participants perusing the Federal Reserve Bank of New York's description of the deal will have found few answers to the questions uppermost in their minds.

To kick off with a few, we do not know the nature of the assets that serve as collateral for the loan. JPMorgan had, on its first iteration of the Bear acquisition, suggested that some of the gross exposure it was taking on, and then offsetting via a non-recourse facility – which one assumes was the Fed loan – was roughly split between commercial real estate and residential (mainly prime and Alt-A) mortgages. The Fed does not identify the collateral that it takes routinely, so its lack of disclosure here is hardly surprising. But it does make it hard to know what sort of credit risk the Fed is running. Likewise, since we do not know what discount to par these assets might have been marked down to, we do not know how much cushion is built into the valuations. All we know is that the portfolio was marked to market. Furthermore, we do not know if the exposure had been hedged. This can make quite a difference, if the hedges are successful, in offsetting the pain caused by further market turmoil.

For other financial institutions holding assets similar to the Bear portfolio, there are other issues to ponder. How quickly will BlackRock – chosen to manage and liquidate the assets– move? Depending on one's perspective here, this may help on the margins, if one believes BlackRock will take a long view and not add to the overhang of beaten-down securities. But the bigger boost to the market has probably already come from the Fed's other dramatic move, in providing liquidity to broker-dealers.

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