The Housing Chronicles Blog: Thoughts on the Bear Stearns bailout

Tuesday, March 18, 2008

Thoughts on the Bear Stearns bailout

Following a lawsuit filed by the National Community Reinvestment Coalition against the Federal Reserve-backed purchase of Bear Stearns by JP Morgan for $2 per share, there have definitely been opposing opinions about this deal. From a USA Today report:

As the government-backed sale of Bear Stearns (BSC) shows, one man's bailout is another man's prudent government action to forestall a financial crisis.

Some have criticized the Federal Reserve for providing $30 billion in financing to facilitate the investment bank's forced sale to JPMorgan Chase (JPM). "I do see it as a bailout. … We may be left holding the bill as taxpayers," says John Taylor, CEO of the National Community Reinvestment Coalition...

The Fed's role in the Bear Stearns sale could end up costing taxpayers — or the government could make money on the deal. In return for $30 billion in financing, Bear provided as collateral difficult-to-price securities that investors now shun. If investor demand recovers, the Fed could turn a profit.

Others say the Fed's action was required to avert an even worse outcome. "You can say you don't want to reward risky behavior but … the sooner that we can clear the decks of the bad events, the sooner we can move forward," says economic consultant Carl Tannenbaum. "Otherwise, the risk is you could continue to see the dominoes falling, one institution after another."

This week's burst of federal action is the latest in a long line of crisis-fighting initiatives. In 1933, Franklin D. Roosevelt established the Home Owners Loan Corp. to help homeowners in danger of foreclosure. In 1984, the Fed provided billions of dollars to halt a global run on the nation's sixth-largest bank, Continental Illinois. Fourteen years later, Fed officials gathered top investment bankers in a New York conference room to prevent the failure of hedge fund Long-Term Capital Management from becoming a global financial crisis.

Yet, some Fed watchers are worried that its willingness to provide financing for investment banks has crossed the line into throwing good money after bad. "A bailout's already occurring under our noses, that we're not even aware of," says Joseph Mason, finance professor at Drexel University.

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