Bear Stearns and the Fed
March 16th, 2008Via: Bloomberg:
Federal Reserve Chairman Ben S. Bernanke is being forced to throw out four decades of monetary history by a financial system choking on miscalculated risks and a deepening recession.
Bernanke and the four Fed governors voted yesterday to become creditors to Bear Stearns Cos., a securities firm that isn’t a bank, by invoking a law that hasn’t been used since the 1960s. Three days earlier, the Fed said it would swap Treasury notes on its balance sheet for privately issued mortgage-backed securities held by Wall Street firms.
“It’s a re-drawing of the relationship of the Federal Reserve with the rest of the financial system,” said Vincent Reinhart, former director of the Division of Monetary Affairs at the Board. Risks of so-called moral hazard, where firms will now come to count on bailouts by a federal agency, “are considerable,” he said.
The cost of doing nothing may have been even greater, say other former Fed officials. Bernanke is attempting to keep the nation’s financial machinery working as record home foreclosures make investors reluctant to hold even bonds backed by Fannie Mae and Freddie Mac, government-chartered firms. The 54-year-old Fed chairman is also trying to contend with a worsening economic slump: Reports this week showed that retail sales unexpectedly fell and consumer confidence slid to a 16-year low.
Meyer’s Experience
“As a governor, you never want to be placed in this position,” said former Fed governor Laurence Meyer, who served during the central bank’s coordination of the rescue of hedge fund Long-Term Capital Management LLC in 1998. “Everybody has to be uncomfortable with this. But it is always, compared to what? Just imagine what would have happened today if this action hadn’t been taken.”
Even with the bailout, stocks retreated. The Standard & Poor’s 500 Index fell 2.1 percent yesterday to 1,288.14. The S&P Financials Index lost 4.1 percent. Bear Stearns tumbled $27, or 47 percent, to $30. Lehman Brothers Holdings Inc., Citigroup Inc. and Bank of America Corp. also declined.
“It has really spooked the market,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said in a Bloomberg Television interview. “It has unraveled so fast that investors are worried about the next shoe dropping.”
