My friend Scott, who actually worked for Bear Stearns years ago, sent me one of the more down to earth explanations of a liquidity trap that I have heard of late. Imagine that you had a mortgage on your house for 50% of its current value. Then suppose that in this alternate mortgage world, you had to renew your mortgage every week. Most of the time, you are fine -- you still have good income and solid underlying asset values, so you get renewed with a rubber stamp. But suppose something happens - say 9/11. What happens if your renewal comes up on 9/12? It is very likely that in the chaos and uncertainty of such a time, you might have trouble getting renewed. Your income is still fine, and your asset values are fine, but you just can't get anyone to renew your loan, because they are not renewing anyone's loan until they figure out what the hell is going on in the world.
Clearly there are some very bad assets lurking on company books, as companies are still coming to terms with just how lax mortgage lending had become. But in this context, one can argue that JP Morgan got a screaming deal, particularly with the US Government bending over and cover most of the riskiest assets. Sigh, yet another government bailout of an institution "too big to fail." Just once I would like to test the "too big to fail" proposition. Why can't all those bankers take 100% losses like Enron investors or Arthur Anderson partners. Are they really too big to fail or too politically connected to fail?
Anyway, Hit and Run has a good roundup of opinion.
Update: I don't want to imply that everyone gets off without cost here. The Bear Stearns investors have taken a nearly total loss - $2 a share represents a price more than 98% below where it was a year or two ago. What I don't understand is that having bought Bear's equity for essentially zero, why an additional $30 billion guarantee was needed from the government.