The Bear FAQs

1. As a result of Bear Stern commodities are falling:

These were bubbles. Speculative bets. When the market becomes unstable, traders get margin calls and have to close out positions preferably in assets that have some gains. These things feed on themselves. Oil was 7% net long which is theoretically the place for a price correction. There was also the fear of settlement risk. See below

2. What happens to the positions that Bear Stearns has had in commodities, for example?

My bet is that this is what scared the Fed. If Bear Stearns went belly up, counter parties would become creditors in a bankruptcy proceeding. It would mean that they could not close out their positions, because their counter party no longer existed. When this happens the dominos start to fall. In 1974, German regulators forced the troubled Bank Herstatt into liquidation. There was a time difference and Herstatt's counter parties in NY did not receive their dollar payments for money they had delivered to Herstatt in Frankfort before it ceased operations. This has become known as Herstatt risk. Specifically it occurs when one party to a foreign exchange trade pays out the currency it sold but does not receive the currency in return. This type of counter party risk or settlement occurs when the markets are in turmoil. It occurred with energy futures back in 2002 with Enron and Dynergy. If Bear went under, there would have been a lot of counter parties hanging.

3. Does JP Morgan take them over, or liquidate? What do you think?

Depends what they find. They got Bear pretty cheap. My bet is that they will keep it.

4.What's your own macro analysis of the Bear Stearns fireside sale: in other words, what's the next shoe to drop, you think?

The next shoe will be banking systems in emerging markets. For example the Kazak banking system borrowed $40 billion from the international banking system. The Russian banks borrowed $140 billion. They lent a lot of the money on consumer, retail and mortgage loans. Right now this does not look like a problem in some of these economies because they have high reserves, high oil, and, for now, strong economies. But as the recession starts to bite, these things will go south. You are starting to see problems every where from the Balts, to Romania to India. The 40% fall in the Chinese stock market must have hurt any number of the 33 million of people who opened new accounts. These countries will probably dip into their reserves to pay back western banks and prop up the locals, but it will hurt.