The Economic Sky is (Still) Falling

I mentioned a few days ago that the only way the Federal Reserve can really prevent the economy from a fiery crash landing is to offer help to the very financial institutions that started this mess. As unsavory as that solution might sound, the Fed can’t really let them all crash and burn because the whole market will follow. That said, the Bear Stearns situation still has a lot of people scratching their heads.

The Fed and Treasury Department encouraged a deal wherein J.P. Morgan will buyout Stearns for $2 a share, one-third the value the company had when it launched in the mid-1980s (total buying price is $236 million). The Fed is coughing up $30 billion to cover the assets of Stearns that aren’t very liquid and offering some risk protection to the buying company. J.P. Morgan in turn is guaranteeing the risks and trades of Bear Stearns. Without this deal, Stearns would have declared bankruptcy.

If the subprime financiers are a bunch of hyperactive schoolchildren, Bear Stearns was the lunch money stealing bully. Ten years ago, when a group of firms bounded together to bailout the Long-Term Capital Management hedge fund long enough for it to liquidate, Stearns refused to participate. There was further bad behavior, documented by Paul Krugman of the NYT:

Bear was a major promoter of the most questionable subprime lenders. It lured customers into two of its own hedge funds that were among the first to go bust in the current crisis.

The message being sent is that the Fed won’t allow even the most despicable of subprime lenders fail and learn their lesson for fear that the market can’t take the impact. More bailouts are coming. It is only a question of who, when and how much.

Tags: Bear Stearns, economy, Federal Reserve, J.P. Morgan