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.
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To the extent that the demise of Bear Stearns can be reconstructed at this junction, it is my view that it was the private refusal of the other ibanks and major financials on Thursday, 13 Mar into Friday, 14 Mar to continue routine counterparty transactions that put BSC into full out thrash mode. The downgrade of Friday only just put the seal of disapproval on the twitching corpse. Bear didn’t jump from that skyscraper window, it was the impetus of half a dozen knives in its back that sent it over into eternity. Yes, there were many and various things the Fed could do to _fund_ Bear going forward—if the other major financials would resume counterparty actions with Bear. Which they steadfastly refused to do so far as can be told, playing chicken with the potential for a ‘derivatives event’ on Monday, 17 Mar if the powers that be didn’t see it their way. Attempts to reflate Bear if the other ibanks wouldn’t play would have been useless, just a way to lose money at once rather than gradually maybe. And since the Fed didn’t and doesn’t regulate the other ibanks, it couldn’t very well force them to open their swap windows. This was greenmail.
And as we see, it worked beautifully. Bear was left to expire. The Fed got jobbed. The other ibanks got all of _their_ existing counterparty exposure to BSC covered at par. And they all got access to the TSLF, minus a competitor. To me, this may be what got under Reinhart’s skin: the other ibanks put a ring in the appendage of the Powers That Be, who now dance to their tune. The Fed has lost all _autonomy_ of action, has handed its full faith and credit over to the speculators in effect. Oh sure, the Fed has never been wholly autonomous of the major money center financials, but now the thieves are running the board meeting for the time being. That’s not just a bad precedent, it’s a terrible and terribly corrupt process.
Does the public know, or much care?? Nahh, they’re to busy betting nickels on the winner of Electoral Idol. Whose contestants are scrupulously silent about all this.
maybe im wrong but it seems that the FED retracted because they took revenge on BSC FOR NOT HELPING THEM IN 1998 in the LTCM bailout.
A lot of people think that the Fed’s actions in the recent crisis – whether acting as defacto ‘market maker of last resort’ and accepting a wider range of securities; or its role in the merger of BSC – is unprecendented.
But this is far from true. The Fed’s actions are well in line with what it has done in the past. The key book here really is Hyman Minsky’s ‘Stabilizing an Unstable Economy’ (which i believe has just come back into print). He describes in detail the Fed’s actions in bailing out REITs in the 1970s and before that, the way it handled the the financial crisis of 1966. A few other crises, in the late 70s and early 80s, are also looked at. In almost every case, the Fed widened the range of securities it would accept at the discount window, and took other steps which now sound more than vaguely familiar.
Minsky then goes on to talk about the moral hazard problems and the fact these actions of the Fed during each crisis, sowed the seeds of future problems. The book (published in the mid 1980s) is truly worth reading for a sense of how Fed policy towards crises has followed a time -tested pattern.
Pardon me that this is late, but The May 2nd NY Times, in an article by Floyd Norris, states that Minksy’s book referenced by “av” has been re-printed by McGraw-Hill. (The context is the Bush admin’s Under-secretary of the Treasury, Robert K. Steel, citing Minksy to explain why they do what they do – apparently, we are all Keynesians again ….)