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Bailouts or Bull****?

With all that’s happened with the real estate and banking crisis, the word “bailout” has been plastered throughout the media with little discussion of exactly what a bailout entails. Supplying money to a distressed company does not by itself represent a bailout. It all depends on where the money is coming from, and whether or not a moral hazard has been created.

Bear Stearns vs. LTCM

Let’s look at some “bailouts” from the past. Let me just tell you right off the bat - Bear Stearns did not receive a bailout. Forget what you’ve read. They’re all wrong. Why do I say this? A true bailout creates a “free ride” for the recipient via government assistance. In other words, a bailout creates a moral hazard - the tendency to behave irresponsibly and/or take on excessive risk - because the penalty for failure has been removed. Thus a moral hazard causes the bailed out company to act irresponsibly in the future, knowing that failure will be forgiven by taxpayer dollars.

Rather than a real bailout, the Bear Stearns deal was a gift to the "kingpin" of the Federal Reserve banking system – JP Morgan - and likely the Fed’s punishment to bear for not participating in the "bailout" of Long Term Capital Management (LTCM) a decade ago.

In the case of LTCM, participating banks received a 90% stake in the fund for money THEY CONTRIBUTED. But similar to the Bear Stearns deal, there was no moral hazard created for LTCM because they had to exchange ownership for cash. In the Bear Stearns deal, the Fed handed JP Morgan $30 billion of taxpayer money, while guaranteeing JP Morgan’s potential losses would not exceed $1 billion.

Considering Bear's clearing and prime brokerage units are most likely worth $18 billion, plus Bear’s $1 billion Madison Ave. headquarters, plus JP Morgan's ability to keep Bear's best employees (probably valued around $2 billion including revenues from client accounts), minus restructuring and retention charges of say $2 billion - JP Morgan will net somewhere around $18 billion on the deal with virtually no risk. Make no mistake about it - this deal will be recorded as one of the biggest financial heists in U.S. banking history once people truly understand what really happened.

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