- The Washington Times - Tuesday, March 18, 2008

The Federal Reserve won both cheers and jeers yesterday for throwing open its lending window to Wall Street brokers and engineering an unprecedented $30 billion rescue of Bear Stearns that looked to some critics like a massive bailout.

The Fed’s moves appeared to accomplish at least one purpose — calming U.S. markets. U.S. stocks and bonds avoided the bloodletting seen in European and Asian markets overnight as news of the U.S. crisis and likely recession set in, prompting the International Monetary Fund (IMF) to warn of ramifications for the world economy.

But many from Washington to Wall Street questioned the growing costs — potentially for taxpayers — of the Fed’s increasingly strenuous attempts to prevent the financial house of cards built by Wall Street from collapsing.

“The Fed has made it clear it will do anything to avoid a calamity — just the confidence boost the market needed,” said Jeffrey Kleintop, chief market strategist at LPL Financial. He compared the Bear Stearns bailout to the Fed-engineered bailout of Long Term Capital Management 10 years ago during the Asian financial crisis, which posed no known risk for taxpayers.

“Every financial crisis has its failure,” he said. “This time, it is Bear Stearns. Perhaps looking back, this will become the pivotal event of the current financial crisis. … Today’s market action suggests that this may be the beginning of the end of the crisis.”

Todd Miller, analyst with RBS Greenwich Capital, said the Fed’s $30 billion loan guarantee facilitating JP Morgan’s buyout of Bear Stearns amounts to a forced marriage that may be a seminal event but it is neither a bailout nor a rescue in light of the grinding losses both firms were forced to bear.

JP Morgan took on Bear Stearns’ multibillion-dollar liabilities in exchange for paying $2 a share for Bear stock that was worth $170 a year ago. Mr. Miller noted that the Bear Stearns office tower in midtown Manhattan that JP Morgan acquired in the deal is worth more than six times the $240 million Morgan paid for the entire firm.

“This was a major brokerage failing,” he said. “Is Bear the cycle’s victim for the history books and we’ll look back and say the bottom was in place? We doubt it. There is still a reeling economy out there, and Wall Street will take the balance of this year to recalibrate its holdings.”

Dwight Cass, analyst with Breakingviews.com, said the Fed may be taking on more than it bargained for.

“This represents a huge increase in the Fed’s support of the brokerage community — a group it doesn’t directly regulate,” Mr. Cass said. The Fed has previously offered loans from its discount window only to banks, which are closely regulated by the Fed and other bank regulators in exchange for their unfettered access to taxpayers’ cash.

The Bear Stearns rescue alone dwarfs any previous bailout by the central bank, while its simultaneous offer to lend cash to any of 19 Wall Street brokerage houses in exchange for AA-rated mortgage securities of questionable value could create an open-ended drain on the federal Treasury, analysts said.

Bear Stearns was a major participant in a $50 trillion universe of credit instruments known as swaps. Its failure threatened to set off a cascade of failures of these credit swaps with the potential to touch other major banks and brokerages in markets around the world. That is the reason the Fed got involved, Mr. Cass said, but it also is the reason it could be assuming liabilities beyond even the Fed’s ability to bear.

“Investors can take comfort from the Fed’s willingness to use its authority and a $30 billion guarantee to resolve the broker’s plight,” Breakingview’s Edward Hadas said. “But the deal leaves three frightening questions: Who is next, will everyone’s flight to safety wreak havoc, and where will the rescue money come from?”

The Fed’s latest in a series of increasingly aggressive moves to infuse cash into markets triggered a political debate in Washington and on the campaign trail.

President Bush said he supports the Fed’s moves, which showed that “the U.S. is on top of the situation.”

But Senate Majority Leader Harry Reid, Nevada Democrat, said it shows Mr. Bush is willing “to bail out Wall Street at taxpayer expense.” He added that the administration should throw its support behind congressional bills that would help consumers who took out bad mortgages — bills that the White House previously dubbed a “bailout.”

Sen. Charles E. Schumer, New York Democrat, applauded the Fed’s moves for being “smart, timely” and carefully targeted at the biggest financial sinkholes on Wall Street. “There is no moral hazard argument here against this action — just ask Bear Stearns shareholders who are receiving just two dollars a share,” he said.

Democratic presidential candidates Sens. Barack Obama and Hillary Rodham Clinton both said they supported the Fed’s moves to stabilize the financial system, but they said the moves showed what a shambles the Bush administration has made out of the economy.

“The news coming from Wall Street today has confirmed our fears that the financial fallout from the mortgage crisis would spill over into the wider economy,” Mr. Obama, of Illinois, said while campaigning in Pennsylvania, adding that the U.S. by all accounts is in recession.

Mrs. Clinton, of New York, said she spoke with Treasury Secretary Henry M. Paulson Jr. and New York Fed President Tim Geithner to relay her “thoughts and concerns” that what started as a subprime mortgage crisis has “spilled over and now poses a broader threat” in part because the administration has not adequately addressed the underlying problem of escalating foreclosures.

The Fed’s emergency interventions prompted an awakening to the extent of U.S. troubles for overseas investors.

In Europe, London’s FTSE 100 index dropped 3.9 percent, while Paris’ CAC 40 fell 3.5 percent and Frankfurt’s Dax lost 4.18 percent. The picture was similar in Asia, where Tokyo stocks plunged 3.7 percent, Bombay nose-dived 6 percent, Hong Kong shed 5.2 percent, and Shanghai declined 3.6 percent.

“The downside risks have materialized,” IMF Managing Director Dominique Strauss-Kahn told reporters in Paris, saying the IMF will lower its forecast for world growth as a result. “Obviously, the financial market crisis is now more serious and more global than a week ago.”

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