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Home > Cases > Bear Stearns Hedge Funds > Fed's Bail-Out Plan for Bear Stearns Creates Questionable Precedent

Fed's Bail-Out Plan for Bear Stearns Creates Questionable Precedent

p>Bear Stearns Cos. apparently has been given a reprieve, following news that the Federal Reserve will provide a 28-day line of credit to the troubled company via J.P. Morgan Chase & Co.

As reported in the New York Times on March 16, 2008, the question is why bail out Bear Stearns?

Consider the following:

  • Bear Stearns is a major player in the mortgage securities business. It has provided generous lines of credit to subprime lenders like the now-bankrupt New Century and is the owner of EMC Mortgage Servicing, a highly aggressive subprime mortgage servicer.
  • Data from Bloomberg show in February 2007 that of the Alt-A mortgages Bears underwrote, 15 percent were delinquent by more than 60 days or in foreclosure. The industry average is 8.4 percent.
  • Last summer, Bear Stearns lost billions for investors, following the collapse of two hedge funds that had invested in mortgage securities.
  • Also occurring last summer, Bear Stearns tried to foist mortgage securities held in its own vaults onto the public via an initial public offering of a financial company called Everquest Financial. That particular deal never got off the ground.
  • In 1998, when the Long Term Capital Management hedge fund required a Fed-arranged bailout, Bear Stearns wanted no part of the effort.

But allowing Bear Stearns to fail is not an option, though several industry insiders believe that's exactly what should happen. The New York Times article characterizes the scene at Bear Stearns as “a classic run on the bank”—the kind immortalized in Frank Capra's homage to financial responsibility, ‘It's a Wonderful Life.’ As fears about Bear's financial position heightened, its customers began demanding their cash and big hedge funds that were using the firm as an administrative back office or lender moved their accounts elsewhere.

“In addition, institutions that had bought credit default swaps from Bear Stearns, insurance policies that protect against corporate bond defaults, were scrambling to undo those trades as the firm's ability to pay the claims looked dicier,” according to the NYT article.

Josh Rosner, an analyst with Graham Fisher & Company and an expert on mortgage securities, says the Federal Reserve's bail-out plan is troubling on many fronts.

“The Fed has now crossed the line in a very clear way on ‘moral hazard,’ because they have opened the door to the view that they are required to save almost any institution through non-recourse loans — except the government doesn't have the money and it destroys the U.S.'s reputation as the broadest, deepest, most transparent and properly regulated capital market in the world,” Rosner said in the NYT article.

By bailing out companies like Bear Stearns, the Federal Reserve may be creating a dangerous precedent. And in the end, of course, the American taxpayer will pay the ultimate price.

In the summer of 2007, our group, who individually and collectively have extensive experience in representing investors against Wall Street, formed an affiliation. Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage related investment losses. Contact us.


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