Fed Comes To Rescue As Wall St. Giant Slips

By Neil Irwin and Tomoeh Murakami Tse
Washington Post Staff Writers
Saturday, March 15, 2008

The Federal Reserve took the extraordinary step yesterday of providing emergency funding to one of Wall Street's venerable firms, Bear Stearns, after it ran out of cash to repay its lenders.

The Fed used a little-known power it last exercised in the 1960s to stem a run on Bear Stearns that could have sent multibillion-dollar losses cascading across the world financial system, causing more failures on Wall Street and threatening to choke off global economic growth.

The Fed's action, arranged in a series of pre-dawn deliberations yesterday, is one of the most significant government efforts to save a private firm in modern times. The nearest parallels are the New York Fed-engineered buyout of the hedge fund Long-Term Capital Management in 1998 and the bailout of Continental Illinois Bank in 1984.

Critics characterized the Fed's move as a bailout that inappropriately intrudes on the free market and could lead banks to keep taking risks like those that imperiled Bear Stearns. Other analysts said the action was necessary, given the precarious state of world financial markets.

"We're on a knife's edge," said Eugene White, an economics professor at Rutgers University who studies financial crises. "The danger is if people's confidence is lost in a place like Bear Stearns, no one will lend to anybody."

But while the Fed may have contained the immediate crisis, the move reinforced widening anxiety over the health of other banks and investment funds exposed to the credit meltdown. Markets tumbled in the hours after the funding plan was announced, with the Dow Jones industrial average finishing the day down 1.60 percent, or nearly 195 points.

Bear Stearns struggled to manage a flood of calls from clients who were trying to redeem their investments. Its stock fell more than 47 percent.

The firm is actively shopping itself to other big Wall Street firms and has scheduled high-level talks over the weekend, said a company official with knowledge of the matter. Bear is also open to selling major divisions to raise cash, the official said. J.P. Morgan Chase, which played a crucial role in yesterday's cash infusion, is a possible suitor.

As Bear's troubles deepened in recent months, it increasingly turned to overnight loans. But on Wednesday and Thursday, its lenders lost faith, and many refused to lend it any more money. That set off a frantic search for cash, including negotiations between executives of Bear and other Wall Street titans.

In the middle of the night, Bear and J.P. Morgan struck a deal. Bear would be willing to put up some of its assets as collateral in exchange for cash from the Fed. The transaction would be routed through J.P. Morgan, which, as a commercial bank, has access to the Fed's discount window. That would give Bear time to raise financing through the private sector.

"What this is is a bridge to more-permanent solutions," Bear Stearns chief executive Alan D. Schwartz said during a conference call yesterday afternoon.

But the deal still needed the Fed's approval. In a series of conference calls from about 3 till 7 a.m., leaders of the central bank discussed whether to exercise an authority granted the Fed in the 1930s -- and not used in four decades -- to approve the loan to Bear Stearns.

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