The Bear Stearns (BSC) acquisition by JP Morgan (JPM) was the focus of a lengthy testimony before the Congressional Banking Committee on Thursday. There were heavy hitters there from JP Morgan, Bear Stearns, and of course the Fed.
The unprecedented deal worked out over the weekend of March 15-16 has raised many issues concerning the government’s role in business and questions about escalating moral hazard. The defense against the claims of impropriety was to play up the calamitous situation that would have ensued had the Fed stayed away and allowed Bear Stearns to fail. To hear them describe the result of a Bear collapse, it would have been a serious crisis of confidence for financial institutions until many banks had been pushed out of business and the economy was in a full blown depression.
The dire predictions offered by many testified seemed to justify this Fed intervention, because had this worst case scenario happened then the Fed would be moved to a much bigger “bailout”. Jaime Dimon, CEO of JP Morgan claimed that the toll to taxpayers of this financial collapse “...wouldn’t have been even close” to the cost of intervening on behalf of Bear Stearns.
The problem with this defense is that it is completely impossible to prove, and thus exactly the thing that these major players needed to take some heat off. One defense that will be provable was what Bernanke used to justify the deal was that he believes that the Fed will not lose money on the $29 billion non-recourse loan.
As taxpayers, we sincerely hope that he is correct, but we find it hard to believe as there was such “substantial risk” on Bear Stearns hands that no one was willing to acquire the formerly well respected investment bank without assistance from the Fed.
The key issue, in our view, is whether this creates a conflict of moral hazard.
