Grin and Bear It

Was the Bear Stearns bailout necessary to keep financial markets and our economy running smoothly? That's what the press is telling us. The only problem is that our economy is in trouble no matter what. The most important outcomes of the Fed's bailout were to make the public purse absorb losses that should have been borne by private investors, delay (and potentially exacerbate) future pain and reckoning, and thwart an accountability process that might have embarrassed some powerful people.

This is just the latest and most desperate/dramatic attempt by the Fed and Treasury to contain a problem that the wizards believe could trigger a financial meltdown. Don't forget the frequent rate cuts, new lending facilities, and Treasury-initiated efforts to prop up failing structured investment vehicles. Without all of this intervention, other large investment banks that helped engineer this mess almost certainly would have gone down by now. This is all being done on the public dime. And so far, not a single significant program to come to the aid of ripped-off homeowners and devastated communities.

The sudden collapse of Bear Stearns, without government intervention, may have made for some gruesome headlines, historic market selloffs, and triggered the downfall of other elements of the unregulated "shadow banking system" believed to be highly exposed to Bear Stearns -- JP Morgan, for instance. Bear Stearns Friday may have been Black Friday, were it not for the Fed action.

But that's because the problem isn't restricted to one bank or fund. The financial markets are an unmitigated disaster right now, and that hasn't changed one bit since the Bear Stearns bailout. For years banks and hedge funds have been loading themselves up with debt and speculating wildly, a massive bubble formed, and what we're seeing is a natural reaction to that. Unless the housing bubble can be replaced by another bubble -- the way housing replaced dot-com -- this economic contraction is bound to happen, regardless of what the Fed does to avert crisis.

So the prospects for the economy and the rest of us, regardless of whether Bear Stearns is kept afloat, are not good, and the media's slavish dedication to the line that this is best for the economy is a disservice to us all, and distracts from the issue at hand: the systemic meltdown that the Fed was supposedly trying to avert is already happening, regardless of whether we can point to a dramatic, one-day crash as the day when it all began to unravel.

The lack of debate surrounding this question also obscures the fact that there were other options besides a do-nothing approach, and that another form of federal intervention could have kept a bankrupt Bear Stearns functioning. Economist Nouriel Roubini laid out an alternative course of action in his discussion of the bailout:

So the appropriate resolution of the Bear insolvency – that would have minimized moral hazard given the Fed liquidity support - would have been to wipe out shareholders, wipe out senior management and then have Bear taken over by the government – rather than sold with a massive subsidy for JPMorgan - as public funds were being used to avoid the systemic effects of its collapse. Public money should have then been used not to bail out the creditors of Bear but rather to ensure an orderly disposal or sale of its operations including inflicting the appropriate losses on Bear’s creditors.

Insolvency is when assets no longer exceed liabilities. Because Bear's assets had been over-valued, it became insolvent. Losses were inevitable, the only question was who would have to absorb them. Actually, this shouldn't be a question - stockholders and then creditors are the most obvious candidates to absorb these losses, as they signed up for this risk when they invested in and lent money to this catastrophe of a financial institution (which has a dismal record of ripping off the public -- see this Nation story about its dealings with the MTA, for instance). Because of the *$30 billion* loan by the Fed, however, the stockholders retain their investments, creditors can expect future payment, and the taxpayer will be footing the bill.

This is the moral hazard issue Roubini was addressing, and it brings up a crucial point that should be central to any debate on this issue: our financial markets tend to privatize gains while socializing losses. Everyone on Wall Street knows this (that's why they're on Wall Street). The upside to gambling with trillions of dollars of other people's money is seemingly limitless, the downside...well, how's this for downside: the inept/negligent Bear chairman, Jimmy Cayne, may have lost hundreds of millions of dollars in the past few weeks, but as of last night he's walking away with "just $61 million" in the words of the New York Times (he cashed out on his Bear stockholdings). This amount should be zero -- or negative, or perhaps he should be in jail?

We are living with the consequences of a financial system that is not held to any reasonable standard of accountability or transparency. In this context, of course, the immediate response from government officials, who are owned by and/or close friends with the bigwigs at these financial institutions, is to stage wild rescue attempts and then gesture towards some form of accountability and regulatory process down the road (maybe, perhaps). And the media believes that this is the right way, the only way.

As the financial crisis deepens, investigations and accountability efforts are of paramount importance. The sooner we hold modern day robber barons accountable for steering our economy towards its present disaster, the sooner we will understand what went wrong (perhaps some people were making too much money?) and what we can do to right the ship. Not to mention addressing the moral hazard associated with bailing out institutions that have acted recklessly. Another bank on the verge of going bust? Let it fail, take control, and march the bank's managers through a process of embarrassing investigations.

This kind of accountability process could make for a better balance of gains and losses in our financial markets. Power would shift away from Wall Street, towards Main Street. Perhaps the federal government would then act prudently in coming to the aid of people who actually need it, for the well-being of their families and their communities. And while we're at it, why not take some of those illegitimate profits back? Maybe it's time to institute a tax on wealth.