Senate to probe bailout by Fed

The debate over bailing out firms hit by the mortgage crisis began in earnest in Washington yesterday.

The Senate Finance Committee said it is probing the Federal Reserve’s bailout of Bear, Stearns & Co. last week, in which the Fed took more than $30 billion of the firm’s mortgage holdings of questionable value in exchange for cash, putting taxpayers at risk of losing money in the transaction. The Senate Banking, Housing and Urban Affairs Committee will hold hearings next week.

Also yesterday, Treasury Secretary Henry M. Paulson Jr. conceded that the access to taxpayer funds accorded to Bear Stearns and another 19 investment firms under the Fed’s rescue plan means they might need to be more strictly regulated, like banks, which traditionally have not been allowed to take the big financial risks taken by such securities firms.

“Congress has the responsibility to look at whether taxpayers will lose money here,” said Sen. Charles E. Grassley, who along with Finance Committee Chairman Max Baucus, Montana Democrat, requested details of the Bear Stearns deal from the Wall Street firm, the Fed, the Treasury and JP Morgan Chase & Co., which agreed to acquire Bear Stearns at a fire-sale price.

“What kind of precedent does this set for federal involvement when other firms over-extend themselves,” the Iowa Republican asked. “Will top executives come out better than rank-and-file workers who weren’t in the room negotiating the deal?”

Mr. Baucus said he wants to know how the government got into the position of “fronting $30 billion in taxpayer dollars for the Bear Stearns deal.”

“Americans are being asked to back a brand-new kind of transaction, to the tune of tens of billions of dollars,” he said. Estimates of losses on the bad mortgages and loans of banks and securities firms range from $400 billion to $1.2 trillion — and many of those could end up in taxpayer hands under the Fed’s rescue operations.

“That’s real money, even in Washington,” said John Rutledge, a former Reagan administration economic adviser.

Historians of past government bailouts say that only luck is likely to prevent the government from losing money. Under the Bear Stearns deal, the mortgage holdings taken over by the Fed, which currently are unfit for sale, will be sold within 10 years, with JP Morgan absorbing the first $1 billion in losses and the rest of the losses borne by the Fed and — ultimately — taxpayers.

“Over 10 years, you might eventually get your money back,” said Janet Tavakoli, president of Tavakoli Structured Finance Inc. “That isn’t costless to the Fed, it isn’t the same as holding Treasuries,” on which the taxpayers would earn interest, she said. On some of the worst quality loans, “you are going to be lucky to get 40 percent” of the original value of the loans, she said.

Mr. Paulson, in an address to the U.S. Chamber of Commerce, admitted that the Bear Stearns rescue “raises significant policy considerations,” as did the Fed’s decision to simultaneously open its emergency-lending window for the first time since the 1930s to a select group of brokers who regularly buy and sell Treasury securities from the Fed’s New York branch. That group of 20 “primary dealers” includes nine European and Japanese brokerages.

“Bear Stearns found itself facing bankruptcy,” Mr. Paulson said. “The Federal Reserve acted promptly to resolve the Bear Stearns situation and avoid a disorderly wind-down. It is the job of regulators to come together to address times such as this; and we did so. Our focus was the stability and orderliness of our financial markets.”

Mr. Paulson stressed that the access to taxpayer funds is intended to be temporary. “Recent market conditions are an exception from the norm,” he said, and the Fed’s moves “should be viewed as a precedent only for unusual periods of turmoil.”

Still, “taking this step in a period of stress recognizes the changed nature of our financial system” and a blurring of remaining distinctions between banks and securities firms, he said.

“The world has changed, as has the role of other non-bank financial institutions, and the interconnectedness among all financial institutions. These changes require us all to think more broadly about the regulatory and supervisory framework.”

Story Continues →