The Fed on a Limb
The Federal Reserve's unprecedented bailout of Bear Stearns was crafted not at the White House or the Treasury but in secret by a New York central banker whose name is unknown to Washington power brokers and who was a Clinton administration presidential appointee.
"It's a new day," commented one investor and longtime Fed watcher. Around the world, that day's dawning is viewed with apprehension because of election-year rhetoric from America.
The plan pressed by Timothy F. Geithner, president of the New York Federal Reserve Bank, effectively substitutes the central bank for the market in determining financial outcomes. Nobody takes seriously the assertions by Fed spokesmen that the aid for Bear Stearns and its dictated bargain-price sale to J.P. Morgan was "extraordinary." In Washington and New York, the question is who will be next. Speculation turned to who else will qualify as "too big to fail."
One candidate was Lehman Brothers, whose stock dropped 19.1 percent the day after the bailout was announced. Government-backed lending agencies Fannie Mae and Freddie Mac have also been seen as bailout candidates.
The central bank's bold new role relieves the pressure on American financiers who have committed serious errors, but it does not reassure investors around the world who are alarmed by what they perceive in the U.S. political process, where class warfare has gained traction. The prospect of a populist new Democratic administration and Democratic Congress that will impose higher taxes and trade protections contributes to what is seen as an international buyers' strike by investors that is feeding the financial crisis.
Startling though the Fed's intervention is, it fits a pattern around the world by central banks -- including the Bank of England. The British central bank first resisted a bailout for the Northern Rock bank in October but was pressed into it by treasury officials in the Labor government. In contrast, the initiative to save Bear Stearns came from the Federal Reserve.
Quick action last week when Bear Stearns was going under contrasted sharply with the normally glacial pace of the U.S. government. Ben Bernanke, Alan Greenspan's scholarly successor as Federal Reserve chairman, of course approved the bailout (as did Treasury Secretary Henry Paulson). But the initiator was the 46-year-old Geithner, who as head of the New York Fed maintains a traditionally intimate relationship with Wall Street. Neither a banker nor an economist, Geithner left Kissinger Associates in 1988 at age 27 to go to work at the Treasury and began an uninterrupted career in government service; he was promoted in 1999 by Treasury Secretary Robert Rubin to undersecretary for international affairs.
Geithner's plan to open the Fed's discount window for the first time to non-banks stunned the financial community but received little attention from a Congress in recess, including presidential candidates preoccupied with Iraq. John McCain was traveling there, while Hillary Clinton and Barack Obama exchanged barbs over who was more antiwar. An influential statement of support for the bailout came from Sen. Charles Schumer, who heads both the Joint Economic Committee of Congress and the Democratic Senatorial Campaign Committee. Although Schumer is not known for nonpartisanship, he is a New Yorker who is close to the securities industry.
The reaction in the hinterland was far less favorable. The Washington office of the Independent Community Bankers of America was flooded by members from across the country complaining of discriminatory favoritism toward their big-city brethren. If they had blundered into financial failure, the community banks said, they would not be bailed out but would be investigated and prosecuted. "Too big to fail," therefore, becomes "too big to be punished."
The expense of such an intervention is not a problem because the Fed, unlike the president and Congress, can print money. The Bear Stearns bailout, approved in private by unelected officials, contributes to paranoid grievances on the left and right that built support for Ron Paul's presidential candidacy. A Fed official conceded privately this week that "we may have crossed a line" in jumping into Bear Stearns -- and that is an understatement. There is no doubt that the U.S. economy is in uncharted territory, with reverberations that cannot be forecast.
© 2008 Creators Syndicate Inc.