I spent a large part of my business career in the wireless industry. When I started, it was a very new industry with few standards and no history or parallels to draw on. Throw in extremely fast growth and we found that many times the need to make quick significant decisions didn’t allow us the luxury of completely analysing and understanding all the implications of a specific move. Sometimes it was more necessary to “do something” rather than “doing nothing” because detailed information wasn’t available, either because we didn’t have the history or things moved so fast that to study and plan for all the implications would make any determined action too late. Often, we would make an educated guess, implement our decision and have to adjust, or in some cases, clean up later. Rather than “Ready, Aim, Fire,” we often found ourselves doing “Ready, Fire, Aim.” I look at the Feds action regarding Bear Stearns as a “Ready, Fire, Aim” situation.
I’ve read numerous articles this week decrying the Feds action to save, support, bail out (pick your favorite descriptive) of Bear Stearns. The complaints range from the capitalism purists who want the market and only the market, to determine the winners and losers without outside influence, to those who see the Feds action as more corporate welfare that gift wrapped a lifetime of Christmas and birthday gifts in one pretty package for JP Morgan. I don’t think either of these perspectives are accurate. In fact, I don’t the the Fed’s action had anything to do with “Bear Stearns” the company at all.
It’s important to remember what the Fed’s responsibility is. Many people think that the Fed’s role is to manage economic growth through its managing of interest rates. While that’s certainly their most visible activity an implication of their actions, and in fact their function has expanded into “fostering a healthy economy,” the reason the Fed was established has nothing to do with managing the economy.
The Fed was established in 1913 as a result of severe panics in the banking system particularly during 1907. As a result, the Fed was established to address these banking panics and foster a sound banking system.
In the Bear Sterns situation, the Fed was addressing the very issue that they were created for; keep confidence in the banking system and avoid collapses or panic of that same system.
In this article from the London Times Online, the author compares the actions of the Fed to those of its counterpart the Bank of England. The author contends:
Had it (Bear Sterns) collapsed, no one knew how many more dominoes would have fallen. The Fed’s bold bailout avoided the much bigger bailout that a collapse would have necessitated, because so many of the counterparties to Bear Stearns’ agreements were banks that do have depositors.
The author further recognizes that the action of the Fed, while staving off the immediate issue, may have unknown implications:
Mervyn King, Governor of the Bank of England, has articulated perfectly valid concerns about moral hazard: that more bubbles will be created unless financiers learn the lessons of their folly.
In other words, the action of the Fed may well have implications that they haven’t anticipated and they will need to learn from the actions taken and adjust accordingly.
The problem with the Fed waiting in this situation is that in times of uncertainty, herd mentality has driven and continues to drive dramatic market swings. Just look at the run up in price of commodities over the past year, especially gold and oil. Now take a look at how quickly the prices of those same commodities drop as they fall out of favor with the herd; gold and oil are down 10% in 3 days. Especially in times of uncertainty, reality and facts are not always the means that people use to make decisions. The lack of liquidity in Bear Stearns occurred in just a few days as rumors of illiquidity caused companies to stop trading with them and essentially caused a “run on the bank.” Left unchecked, this same herd mentality could have spilt over into other banks and put numerous other banks at risk.
The Fed’s action to deal with Bear Stearns was for no other reason than to reestablish or maintain confidence in the banking system. Admittedly, the ramifications of their actions are not fully known but I’m certain that had they done nothing, they would have had a much bigger mess to deal with. Their action has given them an opportunity to continue to attempt to allow the deleveraging that needs to occur in the financial industry in a somewhat orderly manner. Had they not acted, they would still be trying to accomplish that task but would be doing so from a crisis management center. I concur with the Author’s summary of the Fed’s action,
Uncertainty is lethal. Confidence is priceless.
Sometimes “Ready, Fire, Aim” while not perfect, is better than doing nothing at all.
Umnnnhhhhh…
Fed has a problem, yes. The problem: how much monetization is TOO much monetization?
Friedman would probably approve of the B/S action; but Fed already has a lot of USDs floating around which has depreciated the USD significantly in the last 120 days or so.
At some point, somebody’s going to have to take a haircut. B/S shareholders did (at least on paper), but others will have to as well.
“Confidence,” yes. Whoring the USD–that’s another question.
By the way, the crap-mortgage market provided a lot of B/S earnings–and I mean a LOT. So the ‘haircut’ they took was offset by 5 years or so of ….profiteering on Milorganite.
Dad29…
Can’t disagree with you on any of the issues to date. I’d also proffer that the “cause” for this sat right square at the Fed through a combination of abnormally low interest rates and a regulatory side that had become way too hands off. A part of me looks at this like Iraq. Honest people can argue about whether it was the right decision to go. however, we are now there so, what do you want to do about it? Ignoring the problem doesn’t make it go away. Also, Jury is still out on whether this is more than a temporary feel good. All I’d offer as a defense is that each day they buy brings us another day to get through some of the “ciphering” that is going on trying to deleverage. If this thing unwinds overnight it won’t be just the shareholders of the financial companies that will get hurt, it will shoot pain throughout the economy.
One more thing: B/S doesn’t really fall under the Fed’s ‘regulatory authority;’ they are not a commercial Bank.
So the Fed gave the shoe-horn money to Morgan/Chase–the commercial Bank.
You’re right on the macro, however–we haven’t come anywhere close to puzzling out the actual value of subprime investment vehicles. They are certainly worth more than 50-80% of face value, and less than 100%.
It would be nice if a firm number actually emerged.
Agreed on B/S but I think it goes to prove my point. The fed’s action was “manipulated” to impact B/S because they happened to be “it” at the moment. It was also why B/S got into the jam…they had to ability to get liquidity hence the change in the Fed that they are now lending to damn near anyone that can stumble to the window!
On the subprime…this is exactly the issue. The mark to market has caused the financials to be unble to determine what their balance sheets are at any given moment. The result is that banks are writing off their balance sheets unreasonably and at the same time restricting their abilty to loan any more money. I’ve read several articles suggesting that the Fed ought to work to set aside the mark to market requirement for a year…I haven’t figured the down side on this yet. It sounds like it may be a good short term step.