Fed Comes To Rescue As Wall St. Giant Slips

A woman holding an umbrella walks past the entrance of Bear Stearns headquarters in New York in this Jan. 9, 2008 file photo. JPMorgan Chase says that in conjunction with the Federal Reserve Bank of New York it will provide temporary funding for Bear Stearns. (AP Photo/Jin Lee, file) (Jin Lee - AP)

Fed Chairman Ben S. Bernanke, Vice Chairman Donald L. Kohn, New York Fed President Timothy F. Geithner, and Fed Governor Kevin M. Warsh conferred in those early-morning hours on calls, which also included Treasury Secretary Henry M. Paulson Jr. and Undersecretary Robert K. Steel. The Treasury Department had no formal role in the plan, but Fed leaders consulted Paulson and Steel for their financial markets expertise and to get their support.

If they allowed Bear to fail, the rest of Wall Street could have been dragged down with it. A major financial institution would have gone from being worth $8 billion to worthless, overnight.

In normal times, they would be inclined to let capitalism do its work. But markets are so jittery that the policymakers concluded that investors would refuse to make short-term loans to the other big Wall Street banks that rely on such debt, driving them under, too. The stock market could have experienced a collapse of 1987 proportions, and untold damage may have been done to the U.S. economy.

They weighed those fears against the fact that making the loan would put government money at risk. The New York Fed will accept collateral from Bear -- long-term investments viewed as safe -- in exchange for the short-term loan. In theory, that should protect the government against losses. But if the value of the collateral drops, the Fed could end up losing money.

And Fed officials worried about "moral hazard," the notion that other companies might behave irresponsibly if they think they too could get government help if they get into trouble.

The Fed's board of governors voted 4 to 0 in favor of the loan at its Constitution Avenue NW headquarters at about 9 a.m. (The fifth Fed governor, Frederic S. Mishkin, was traveling).

Some analysts said the Fed's effort, coupled with two major actions in the past week to restore order to credit markets, has undermined its credibility.

"There is a growing sense in the market that the Fed is becoming increasingly inept or unable to really do much about this situation," said James Paulsen, chief investment strategist at Wells Capital Management.

For Bear, it is the latest foray into the financial upheaval that began in the summer. Bear was one of the leading packagers of the exotic securities linked to subprime mortgages at the heart of the crisis. In June, two Bear-controlled hedge funds helped spark the worldwide credit squeeze.

The company, founded in 1923, has long been one of Wall Street's most profitable, but smaller and underappreciated, firms. The Bear, as it's known, "has always been the Rodney Dangerfield of investment banks," Fortune magazine once wrote. "It made money but never got much respect."

Its former, longtime chief executive, Alan "Ace" Greenberg, ran its trading floors with hands-on flair and charismatic bravado. But his employees were not drawn from the Ivy League upper crust who inhabited so many other financial firms. They were what Greenberg called "PSDs," people who grew up poor, smart, and with a desire to become wealthy.

Bear Stearns has a reputation for paying its senior executives top dollar. It has also had occasional run-ins with the law.