By Neil Irwin
Washington Post Staff Writer
Friday, April 4, 2008
Senators grilled the engineers of the Federal Reserve rescue of Bear Stearns at a hearing on Capitol Hill yesterday, expressing concerns about the financial risks the government took on, the precedent it set and the failures that led to that point.
Most members of the Senate Banking Committee expressed support for the actions taken by the Fed to extend an emergency loan to Bear Stearns on March 14 and to back $30 billion in assets to make possible its acquisition two days later. But they had pointed questions about many of the details.
"I happen to believe that this was the right decision considering everything that was on the table in the closing hours on that Sunday," said the committee chairman, Christopher J. Dodd (D-Conn.). "The alternative -- and I don't think this is hyperbole -- could have been devastating, both at home and around the world."
Dodd suggested, however, that the situation could have been avoided if the Fed had not refused, before Bear Stearns unraveled, to make its discount window for emergency loans available to investment banks. Bear Stearns chief executive Alan D. Schwartz, who has repeatedly characterized his firm's downfall as a crisis of confidence rather than a failure of its underlying business, embraced that thinking.
The Fed decided to make that emergency cash available to investment banks on March 16, aiming to prevent Bear Stearns's problems from dragging down much of Wall Street. Senior Fed officials disputed the suggestion that they should have done so sooner.
"The way the Federal Reserve Act is designed, and the way we think about the discount window for banks, is we only allow sound institutions to borrow against collateral in that context," said Timothy F. Geithner, president of the Federal Reserve Bank of New York. "And I can only speak personally for this, but I would think -- I would have been very uncomfortable lending to Bear, given what we knew at that time."
Dodd was not the only one wishing that regulators had shown more foresight. Sen. Charles E. Schumer (D-N.Y.) asked, "Could a reasonable regulator have known and been ahead of the curve here? Could someone have called Bear in and said, 'You need more capital. You need to reduce your exposure to mortgages.' ?"
Geithner defended the Fed's response to the crisis. "These things can happen incredibly quickly in markets like this. What the world is going through and has gone through in the last nine months are truly extraordinary, described by many as the worst in 50 years, worst in a generation. . . . Because it's easy to look back and say, 'But doesn't it look obvious?' And I think that's slightly somewhat unfair" to the people involved.
Some senators were also concerned that public money could have been placed at unnecessary risk when the Fed agreed to guarantee $30 billion worth of Bear Stearns assets in its bargain-basement acquisition by J.P. Morgan Chase. (In a subsequent renegotiation, J.P. Morgan agreed to absorb the first $1 billion of any losses that result from selling those assets.)
The New York Fed released some details of what those assets include -- primarily mortgage-backed securities that are rated BBB- or above by credit-rating agencies and which are continuing to receive scheduled interest and principal payments despite the turmoil in mortgage markets. The Fed has contracted with asset management firms to sell the securities gradually over up to 10 years; if they fetch less than $29 billion, the Fed will lose money on them.
"You've got about $30 billion of collateral," said Sen. Jack Reed (D-R.I.), "but a lot of highly rated collateral these days is being subject to questions."
James Dimon, the chief executive of J.P. Morgan Chase, said his firm would have been unwilling to make the deal had the Fed not offered that backing. "While we wanted to help, we had to protect the interests of our shareholders," he said. J.P. Morgan, not the Fed, took on many of Bear's riskiest assets, Dimon added.
Senators also questioned government officials, including Fed Chairman Ben S. Bernanke, Securities and Exchange Commission Chairman Christopher Cox, and Treasury Undersecretary Robert K. Steel, about what lessons the events of the last month offer.
Geithner provided the most detailed recommendations, arguing for stronger "shock absorbers" for cash levels at banks and large investment firms. He also wants a simpler system of regulation for financial entities, and for the infrastructure in markets for arcane financial contracts and forms of debt to be bolstered to better be able to handle the failure of one of its participants.
Geithner further said the government should reevaluate how it makes emergency cash available to financial institutions, and give the Fed the power and responsibility to respond quickly to threats to the financial system.
When questioned on many details, the government officials repeatedly said the action was necessary to protect the economic system as a whole.
"What we had in mind here was the protection of the financial system and the protection of the American economy," Bernanke told the committee. "And I believe that if the American people understand that we were trying to protect the economy and not to protect anybody on Wall Street, they would better appreciate why we took the actions we did."