The Snowball_ Warren Buffett and the Business of Life - Alice Schroeder [501]
“The speed with which fear can spread—nobody has to have an account at Bear Stearns, nobody has to lend them money. It’s a version of what I went through at Salomon, where you were just inches away all the time from, in effect, an electronic run on the bank. Banks can’t stand runs. The Federal Reserve hasn’t bailed out investment banks before, and that was what I was sort of pleading back there in 1991 with Salomon. If Salomon went, who knows what kind of dominoes would set off. I don’t have good answers to what the Fed should do. Some parts of the market are pretty close to paralyzed. They don’t want contagion to spread to what they would regard as otherwise sound institutions; if Bear fails and two minutes later, people worry that Lehman fails, and two minutes after that they worry that Merrill will fail, and it spreads from there.”
The rational Buffett tried to unlock the puzzle embedded in the risky choices facing the Federal Reserve. It had no really good options. Either it allowed a financial meltdown or it took actions that would promote inflation by adding to downward pressure on the dollar. “It could all end on a dime if they flooded the system with enough liquidity, but there are consequences to doing that. If dramatic enough, the consequences would be the immediate expectation of huge inflation. A lot of things would happen that you might not like. The economy is definitely tanking. It’s not my game, but if I had to bet one way or another—everybody else says a recession will be short and shallow, but I would say long and deep.
“You absolutely never want to be in a position where tomorrow morning you have to depend on the kindness of strangers in the financial world. I spent a lot of time thinking about that. I never want to have to come up with a billion dollars tomorrow morning. Well, a billion I could. But any significant amount. Because you just cannot be sure of anything. You have to think about things that have never happened before. You always want to have plenty of money around.”
All weekend the regulators and bankers toiled, much as they had years earlier on Salomon. This time, however, it was with the almost certain knowledge that the bank’s failure would have catastrophic consequences to the global financial system. Whether Bear Stearns deserved its fate was not at issue. Just before the Tokyo markets opened on Sunday, the Federal Reserve announced that it had orchestrated a sale of Bear to investment bank JP Morgan Chase for a pittance. Buffett had been offered the deal, but thought it contained too much open-ended risk.
The same day that the Bear bailout was announced, the Federal Reserve, attempting to calm panic and prevent a run on Lehman Brothers, did indeed begin to flood the system with liquidity: It offered to let the largest investment banks borrow up to $200 billion at its “discount window,” using mortgage-backed securities as collateral. Use of the discount window, formerly a privilege restricted to commercial banks, had never before been extended to investment banks, which are not subject to the reporting and capital regulations that are a quid pro quo for such borrowing. The move didn’t calm the panic; then the government made the offer open-ended. The government was going to accept bad loans as collateral; it began to take a variety of once again unprecedented steps to try to unfreeze the mortgage markets and help struggling lenders. Market pundits praised the Fed’s rescue of Bear and pump-priming of the investment banks as the only way to prevent contagion, but argued whether these actions would hasten an economic recovery or only prolong the