Federal Reserve Chairman Ben Bernanke testifies before the Senate Banking Committee hearing on the Bear Stearns situation along with Securities and Exchange Commission (SEC) Chairman Christopher Cox, Under Secretary of Treasury for Domestic Finance Robert Steel, and the President of the Federal Reserve Bank of New York Timothy Geithner April 3, 2008. (Photo: TIM SLOAN/AFP/Getty Images)
by Frank James
A lot of discussion this morning on Capitol Hill at today's hearing by the Senate Banking, Housing and Urban Affairs Committee on the Federal Reserve's engineering of the $30 billion Bear Stears salvation plan (notice I didn't call it a bail-out.)
Fed Chair Ben Bernanke, Securities and Exchange Commission head Chistopher Cox et al are doing as much as they can to paint a pretty dire picture of what might have happened if Bear Stearns hadn't been helped. The crisis, in their view, would've infected the entire, already ailing economy in unpredicatble ways. Well, not entirely unpredictable. They predict there would've been some ghastly consequences.
In short, the financial markets would have gone south quickly if Bear Stearns had been allowed to go bankrupt, which it was only hours away from doing if nothing had been done on March 16-17.
Said Bernanke:
Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain. Moreover, the adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability.To prevent a disorderly failure of Bear Stearns and the unpredictable but likely severe consequences for market functioning and the broader economy, the Federal Reserve, in close consultation with the Treasury Department, agreed to provide funding to Bear Stearns through JPMorgan Chase.
For those who say the federal government bailed out Wall Street while doing little for Main Street, Timothy Geithner, president of the New York Federal Reserve Bank had this message:
Absent a forceful policy response, the consequences would be lower incomes for working families, higher borrowing costs for housing, education, and the expenses of everyday life, lower value of retirement savings, and rising unemployment.
In other words, to save Main Street a lot of pain, federal officials had to save Wall Street. They could have let Bear Stearns take the bullet of bankruptcy, but that bullet would have had such a strong velocity it would have gone through the Wall Street firm and torn into millions of innocent bystanders behind it.
Cox of the SEC said that Bear Stearns was in such trouble it couldn't borrow money even when it put up as collateral Treasury bonds that were significantly in excess of the amount Bear wanted to borrow.
In their opening statements, several senators raised the issue of moral hazard, the idea that by helping Bear Stearns be acquired by JP Morgan, federal officials may have created the conditions that future firms might take the risks Bear Stearns did.
But Robert Steel, Treasury Under Secretary for Domestic Finance, indicated that one of the reasons for the low initial $2 a share price for Bear Stearns was to factor in a penalty that would speak to the moral hazard concerns.
Not a whole lot of contention this morning. It's clear most of the senators accept the line of the federal officials that they did what had to be done to save the economy from a massive implosion.
One senator, however, Jim Bunning, a Kentucky Republican, appeared to be out of step with his colleagues. He called the Bear Stearns transaction "socialism" and castigated the federal officials for not allowing the "invisible hand" of capitalism throttle Bear Stearns into the grave.
But his was a minority opinion.
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