Fed rescue of Bear Stearns raises specter of Depression-era crash
By  Barry Grey
World Socialist Wed Site
15 March 2008

The Federal  Reserve Board on Friday took emergency action to prevent the 
collapse of Bear  Stearns, the fifth largest US investment bank and one of the 
world’s largest  finance and brokerage houses.
Invoking a little-used provision added to the  Federal Reserve Act in 1932, 
at the height of the Great Depression, the US  central bank agreed to allow the 
Federal Reserve Bank of New York to insure an  infusion of credit to Bear 
Stearns by JP Morgan Chase. Under the terms of the  “secured loan facility,” to 
extend for up to 28 days, the risk of a default by  Bear Stearns will be borne 
by the Federal Reserve Bank of New York, not JP  Morgan Chase. The latter 
will serve essentially as a conduit for the cash  provided by the US central bank.

This mechanism was used because only commercial banks, so-called depository  
institutions, can borrow directly from the Fed’s discount window. Bear Stearns 
 is not a depository bank, and hence the Fed was obliged to invoke a 
provision of  the 1932 amendment to the Federal Reserve Act that applies when “unusual 
and  exigent circumstances exist and the borrower is unable to secure 
adequate credit  accommodations from other sources.”
The announcement of the Fed bailout sent  shivers through Wall Street and 
shook financial markets around the world. It  confirmed rumors that had been 
mounting over the past week that Bear Stearns,  the second largest US underwriter 
of mortgage bonds, did not have the cash to  meet claims by its creditors. The 
rescue operation came one day after the  collapse of Carlyle Capital 
Corporation, a $22 billion publicly traded  investment fund controlled by the Carlyle 
Group, long one of the most profitable  and well-connected private equity 
firms in the US.

With the de facto collapse of Bear Stearns, however, the housing and credit  
market collapse has claimed one of the titans of Wall Street. Founded in 1923  
and employing some 15,500 people worldwide, Bear Stearns was one of the “big  
five” Wall Street investment banks. In 2005-2007, Bear Stearns was recognized 
as  the “Most Admired” securities firm in Fortune magazine’s “America’s 
Most Admired  Companies” survey.
Last July, the collapse of two Bear Stearns hedge funds as  a result of the 
bursting of the US housing bubble sparked a crisis of confidence  in the credit 
system that has gathered steam and expanded in scope to threaten  the 
viability of some of the biggest banks and financial institutions in the  world. The 
worsening credit crunch has deepened the crisis in the housing market  and the 
economy in general, plunging the US into a recession and wreaking havoc  with 
the economies of Europe and Japan.

The news of the bailout sent share prices tumbling on Wall Street. The Dow  
Jones Industrial Average fell 194.65 points, a drop of 1.6 percent. The 
Standard  & Poor’s 500 Index fared even worse, giving up 27.34 points (2.1 percent),  
while the Nasdaq Composite Index fell 51.12 points, or 2.3 percent.
Nine  stocks fell for every one that rose, and the fears that other financial 
houses  could follow Bear’s demise was reflected in a 4.1 percent fall in the 
Standard  & Poor’s Financial Index. All 92 members of the index lost ground 
during the  trading day.

Bear Stearns stock plunged $27, or 47 percent, to end the day at $30.  Coming 
on the heels of a months-long slide in the bank’s stock price,  yesterday’s p
anic sell-off reduced Bear Stearns’s market valuation to $4.1  billion, less 
than one-fifth the size of Lehman Brothers.
Indicative of the  broader reverberations from the Bear Stearns collapse, the 
share price of Ambac  Financial Group, the world’s second-largest bond 
insurer, fell 93 percent, on  widespread fears that the company will not have 
sufficient capital to meet  claims from its creditors.
The US dollar hit new lows against the euro and  other currencies.

The Fed action on Friday confirmed speculation that its extraordinary  
announcement three days earlier that it would loan $200 billion in Treasury  bonds 
to investment banks and brokerages and accept as collateral privately  issued 
mortgage-backed securities—whose market value has plummeted—was a  desperation 
measure aimed at forestalling the failure of a major Wall Street  finance 
house.
Speaking of Friday’s Fed rescue operations, the Wall Street  Journal Online 
wrote: “The timing of the move made its urgency clear: If Bear  could have held 
out until March 27, it could have borrowed directly from the Fed  itself 
under a new program announced just Tuesday.”

The maximum size of the loan is not predetermined, but is limited by how  
much collateral Bear Stearns can provide to satisfy the Fed’s requirements,  
officials said. The loan by no means assures Bear Stearns’s survival. More  
likely, it was granted in the hope that it would buy time for a more orderly  
disposition of the firm’s fate and head off a panic response by bankers and  
investors to its demise.
As the Wall Street Journal Online noted, “The  developments could mean the 
end of independence for Bear, founded in 1923. JP  Morgan said it is ‘working 
closely with Bear Stearns on securing permanent  financing or other alternatives 
for the company’—Wall Street lingo for a sale of  other strategic-level 
change—and CNBC reported that the bank is ‘actively being  shopped’ to potential 
buyers.”
Officials at Standard & Poor’s and Moody’s  Investor Services met Friday to 
discuss whether to downgrade Bear Stearns’s  credit rating, and if so, by how 
much.

In its own statement on the bailout, Bear Stearns said, “The company can  
make no assurance that any strategic alternatives will be successfully  completed.
”
Carl Lantz, a strategist at Credit Suisse, said the intervention  by the New 
York Fed and JP Morgan showed that Bear “didn’t have enough money to  turn 
the light on this morning.”
Geoffrey Yu of UBS said, “I don’t think the  market has seen anything of 
this magnitude before, such a big bank.”
Wall  Street Journal columnist Peter A. McKay wrote: “For investors, the 
arrival of  the Federal Reserve and JP Morgan Chase with a financial life raft for 
troubled  Bear Stearns served primarily as a reminder of how murky and deep 
the waters of  Wall Street’s credit crisis remain, with other market 
participants possibly  drowning below the surface.”

The immediate fear motivating the Federal Reserve, the Treasury Department  
and Wall Street banks was the danger that an uncontrolled collapse of Bear  
Stearns would have a domino effect on already turbulent financial markets. Were  
Bear Stearns forced to sell off assets at fire-sale prices to raise cash 
needed  to meet creditors’ demands, the value of untold billions in assets held by 
other  financial institutions would drop, leading to more margin calls from 
creditors,  further institutional collapses, more panic selling of debt and 
securities—a  vicious spiral to the bottom with the potential of a breakdown in 
the entire  capitalist financial system.
The temporary reprieve for Bear Stearns does not  eliminate the potential for 
just such a scenario in the near future.

The underlying problem is the vast credit bubble that was inflated on the  
basis of reckless and intrinsically unviable home loans and other forms of  
speculation, including leveraged buyouts and a vast expansion in unregulated  
credit markets that delivered unsustainably high returns on investment. The  
immense fortunes amassed by the uppermost echelons of the US population on the  
basis of such parasitic financial operations have created, as their consequence,  
a social and economic disaster of historical proportions, threatening tens of 
 millions of Americans, and hundreds of millions more people around the 
world,  with pauperization.
President Bush, perhaps the consummate political  personification of the 
social layer that benefited from the now-imploded  speculative bubble, spoke 
Friday before the Economic Club of New York, only  hours after the rescue of Bear 
Stearns had been announced. Moving from platitude  to platitude, he declared 
the US economy “the envy of the world,” referred to  the financial crisis as a “
rough patch,” and reassured his audience that “in a  free market, there’s 
going to be good times and bad times. That’s how markets  work.”
The only substance of his remarks was opposition to any resurrection  of 
government regulation of the banks, denunciation of proposals, such as the  timid 
half-measures being advanced by congressional Democrats, to contain the  
growing wave of home foreclosures, and a restatement of the demand that his tax  
cuts for the wealthy be made permanent.

His speech did nothing to reassure the financial markets, which are too  
mired in crisis to buy into the fool’s paradise “optimism” of the commander in  
chief. Martin Feldstein, a conservative Republican who served for a time as  
Ronald Reagan’s chief economic adviser, summed up the growing sentiment in a  
speech to a conference in Florida. “I believe,” he said, “the US economy is now 
 in recession. The situation is bad, it’s getting worse and the risks are 
that  the situation could be very bad.”





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