Greg Ip of the Wall Street Journal reports on the harsh criticism of the Fed’s role in the Bear deal by Vincent Reinhart, who rcently was the Fed’s most senior staff member.
What is ironic about the Fed’s bailout is that it is unpopular on the left and the right. The left does not like the spectacle of subsidies to the until-recently-highly profitable financial services sector, particularly when salvage programs for individuals are getting more talk than action. Reinhart, who was on a panel at the American Enterprise Institute, illustrates the views of some (many?) on the right: perhaps Bear should have been saved, but not via the government shouldering the risk.
Two further points: Reinhart describes other options the Fed could have taken, yet omits the most obvious: lending to Bear for 28 days via JP Morgan, which appeared to be the initial plan, but which the Fed retracted and instead made a mere commitment through the weekend. Bear officials had thought they could pull through with the longer loan, particularly since the new Term Securities Lending Facility was going to become operational before that loan matured. The only explanation I can come up with (aside from nefarious ones) is that the Fed did not feel it could lend to Bear after it was downgraded on Friday March 14 by the rating agencies to just above junk.
The other is that Reinhart comments approvingly on the Fed’s role in the LTCM rescue. Yet at the time, a lot of observers were critical of the central bank orchestrating a deal for an institution it did not regulate with a lot of institutions it similarly did not regulate. This was seen in some quarters as a significant and unwarranted increase in the Fed’s reach. But remember even then that while the Fed assembled the exposed firms (not telling them who else would be there) and told them why it would be in their interest to rescue LTCM, the Fed played no role in the negotiations. Thus, while Reinhart says that the Fed can no longer act as an honest broker, that is counterfactual. The Fed was not a broker in the LTCM deal.
From the Journal:
The Federal Reserve’s rescue of Bear Stearns Cos. will come to be seen as its “worst policy mistake in a generation,” a former top Fed staffer said.
The episode will be seen as comparable to “the great contraction” of the 1930s and “the great inflation” of the 1970s, Vincent Reinhart said…
His appraisal is one of the harshest yet by a high-profile observer…..Mr. Reinhart said the bailout “eliminated forever the possibility the Fed could serve as an honest broker.” In 1998, the Fed coaxed private creditors of Long-Term Capital Management to bail out the hedge fund but didn’t have to put up its own money. If it ever tries a similar maneuver on a Wall Street cohort, he said, “The reasonable question any person in the room will ask is, ‘How much will you contribute to the solution?'”
Mr. Reinhart said the Fed’s move may have been justified if the alternative was a chain-reaction run on many other investment banks. But he asked if other options were available, such as taking a “tougher line” with J.P. Morgan, seeking other suitors, removing certain assets from Bear’s portfolio or quickly implementing its previously announced offer to temporarily swap Treasury securities for dealers’ less liquid assets. “All those things were possible but not pursued,” he said.