It’s the day after Easter, in the spring of 2008.
The Federal Reserve agrees a $29bn loan for JP Morgan to acquire troubled bank, Bear Stearns; a fire sale, it is hoped, that will ease market fears.
The loan is made against a portfolio of Bear Stearns assets, valued at $30bn as of March 14. Under the terms of the deal, the Fed plans to create a special purpose vehicle (SPV) to hold onto the assets (mostly mortgage-related securities) until they can be sold off.
BlackRock is appointed manager of the portfolio, which is soon dubbed Maiden Lane (I). The fund manager is charged with extracting enough value from the portfolio to “pay off the Senior Loan, including principal and interest, while refraining from investment actions that would disturb general financial market conditions.”
Concerns over moral hazard immediately crop up. Bank of America analyst Jeffrey Rosenberg worries that the Fed has taken on a new and very different role; effectively become the buyer of last resort. Others speculate that the action means other banks might begin to count on the Fed for bailouts.
But the central bank is adamant that letting Bear Stearns — a bank with thousands of counterparties — fall into bankruptcy would roil financial markets.
In his April 2 testimony to the US Congress, Fed chairman Ben Bernanke notes that “with financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence.”
Congressman Robert Casey Jr, a Democratic senator for Pennsylvania, remains concerned, or at least anxious enough to probe Bernanke on just what assets are collateralising the $29bn Fed loan.
To which, as NYT Dealbook reports at the time, Bernanke responds:
. . . the assets making up the Fed’s collateral were “entirely investment grade, entirely current and performing.” [Bernanke] said BlackRock, which the Fed has hired to manage the collateral, is “confident, or at least reasonably confident, that we would be able to recover the full amount.”
Fast forward to later that year.
Bloomberg News files a lawsuit in November 2008 to force the Fed to release details of the Bear Sterns bailout, as well as other collateral taken on as part of some of its emergency liquidity operations. Others call for a full-on audit of the central bank.
On April 1, 2010, the Federal Reserve releases detailed information of Maiden Lane I, as well as two other `Maiden Lane’ SPVs created during the bailout of insurance company AIG. The information runs to 161-pages and contains hundreds of bonds, identified by so-called CUSIP numbers.
In the Maiden Lane I portfolio sits one CUSIP in particular: 37638WAA9, or GLCR 2004-2A C.
As of December 26 2007, about three months before the Bear Stearns bailout would be announced and Bernanke would respond to Robert Casey Jr in Congress, the bond has a Moody’s rating of B2, according to Bloomberg data. That’s decidedly below investment grade, six notches above default, and what the rating agency says means the bond is “speculative and … subject to high credit risk.”
By April, when the Fed is finalising the terms of its loan, the bond has been downgraded to Ca — just two notches above default on Moody’s scale, and equating to “highly speculative” and “likely in, or very near, default.”
The bond is currently rated at C, or with little prospect of recovery according to Moody’s.
(H/T The Real Limey for the Maiden Lane CUSIPS in Excel form)
Related links:
In the Fed we TruPS – FT Alphaville
Thoughts on Maiden Lane III - The Aleph blog