Despite the profound anti-regulatory bias in the US, don’t think we are so far away from this transition. Congress tends to do what ‘experts’ advise; if the Fed wise men march in formation and say “Give us the tools, or you can chop cotton yourself,” we’ll see movement. So the fact that a Fed vice-chairman is letting his name be attached to the idea tells you how far along we actually are. I’m of the view, expressed before, that most of the larger commercial and ibanks are capital-dead, or will be once asset values force their reality into the discussion. The Fed sees the books of many of them, and knows this: that’s why they are looking for solutions _and_ desperately putting off asset price discovery.

Nationalization must happen if we are to get to the other side of this thing. We need action by Congress to make this happen. Oh, and ‘a massive subsidy to JP Morgan’ is so right. I’m less offended by BSC’s stakeholders forcing their price up—I mean they weren’t declared insolvent, so what else are shareholders gonna do, lie down on the train tracks for the public good?—than I am by Morgan’s exploitation of the Fed’s fecklessness and lack of appropriate tools.

I agree I may be too optimistic, but the one thing that may embolden Congress is they know the budget is a complete mess, and it is already going to be tough to scrounge up the dough for the various homeowner bailout programs under consideration. They have no tolerance for Wall Street eating into their available funds.

I also agree the systemic risks were overblown. I bet the real issue was that they didn’t want price discovery on Bear’s holdings.

I hope you’re right about the result of the hearings. I remain not very sanguine. If Congress merely acts (or threatens to act) to prohibit another Bear-style rescue by the Fed, then, without proposing a positive law to handle things differently, there will be screams of tying the Fed’s hands, endangering the financial system, etc. While I believe that the systemic risks of a Bear bankruptcy were overstated, that’s a distinctly minority view, and I don’t envision our august legislators having the political courage to risk a second Fed-less IB bankruptcy. As with funding for Iraq, lots of sound and fury and nothing more.

Steve

Your are right that the hearings will be largely grandstanding EXCEPT Congress can and probably will block Bernanke from going out and doing another rescue.

The first comment holds true: we have an enormously well-inculcated anti-regulatory bias here. The train wreck will have to inflict lot more damage before that ideology becomes unpopular. Then we might see some action.

Then UBS comes out and is talking $18 billion!!!! And, there may be another $10 behind that! These numbers are huge. Clearly this is beyond the capacity of the Fed and other to control.

I agree with your reply to my comments. But consider the extent of regulatory overhaul that would be necessary for the Fed to (legitimately) act as receiver for a failed IB. What we’re talking about is a level of regulation that I don’t see being discussed in DC (and have no doubt, Schumer and Dodd would quietly help to kill it). I expect to see a lot of grandstanding, posturing and finger-waving at Bernanke, but not a single concrete bit of legislation to do anything differently next time. No one in DC wants a `bridge’ IB, capitalized by taxpayers, with employees earning 7 figures. Won’t happen. Perhaps the most frightening thing about the Bear rescue is that, quite clearly, the Fed and Treasury had no contingency plans. It would seem that such an eventuality was waved away with a, “oh, let’s not think about that”. The upshot is an improvisation, with the Fed as the main actor in order to provide political cover to the Executive Branch. Paulson wasn’t going to sign anything. So what we have is a “let’s bury it in an LLC, with no public disclosure of the kind of crap Bear held on its books”, and absolutely no will to legislate a better and more equitable way.

Steve (for some reason, my Google/Blogger ID isn’t working)

One big issue here is that the Fed and Treasury have been pretty dishonest, or at least far less than forthcoming, about why they did what they did.

The Fed had no jurisdiction. They couldn’t declare Bear to be insolvent. They’d have to wait for them to declare bankruptcy. The mechanics of dealing with Bear’s positions via a bankruptcy judge would reportedly be pretty horrific for counterparties. But they have never stated that they were constrained by lack of authority to do a deal through a regulated party that shareholders would approve. And by the Fed not being candid, this can be used as a precedent.

As for Congress, there are hearings on Bear this week, and I wouldn’t rule out Congressional action. This is a turf battle over the power of the purse, and the Fed really has overstepped big time. The Fed has just created a big contingent liability which is likely to result in hard costs down the road. That means its rescue has budgetary implications. Congress is highly likely to rein in the Fed somehow here. And this puts the Fed in an embarrassing position. Either they have to say that Bear was insolvent (which is contrary to what the SEC, Bear’s primary regulator, maintains) or they will have to come up with some excuse. Merely invoking systemic risk and not going further probably won’t wash.

When an insured depository institution fails in the US, it’s shareholders are wiped out (they become creditors of the receivership estate). That’s by operation of statute. In exchange for the rents obtained through deposit insurance protections, the equity holders have no say in the timing or disposition of the bankruptcy estate. Right now, we have grotesque moral hazard because the shareholders of IBs have given up nothing in exchange for the rents obtained by access to cheap gov’t funding. Despite the failure of Bear, there is absolutely no movement in Congress to prevent moral hazard with the IBs–which is a good indication of extraordinary financial influence in the political process maquerading as concern for systemic risk.