Failure was not an option
What will the Federal Reserve do the next time Wall Street gets into trouble?
Fearing frozen credit markets could strangle the economy, the Fed backed the sale of Bear Stearns Cos. and offered to help other firms over the weekend. Some people applauded the decision; others didn't. But the Fed stepped over a line and changed the financial world in big ways. The next time Wall Street finds itself in trouble, the Fed will be expected to do something.
The Fed didn't just back up JPMorgan's purchase of Bear Stearns with a $30 billion guarantee. It also offered to lend money to dozens of securities dealers on the same favorable terms that it makes available to commercial banks at its discount window. That new offer, the biggest expansion of the Fed's lending authority since the 1930s, will remain in effect for at least six months.
Protecting the economy in general and the banking system in particular used to mean the Fed supervised and supported commercial banks that made loans and took deposits. Investment banks that traded, brokered, and underwrote securities, a much more volatile business, were not part of the Fed's agenda. Now they are.
Just yesterday, some investors wondered if brokerage firm Lehman Brothers Holdings Inc. was too big to fail? Translation: Will the Fed and chairman Ben S. Bernanke step in again and save Lehman if it also gets into big trouble?
The fire sale of Bear Stearns to JPMorgan Chase & Co. prompts questions like that. Lehman executives went out of their way to assure the world they could ride out the credit crisis. Still, Lehman shares finished yesterday down $8.24 to $31.02. The stock had bottomed out at $20.25 earlier in the day.
For many decades, a handful of giant com mercial banks were considered too big to fail.
They were so big, with financial relationships so vast, that their collapse would be economically devastating and could not be allowed to happen. If necessary, the Fed was expected to step in and do something to save a commercial bank that was too big to fail.
Now, the same idea seems to apply to investment banks and securities dealers like Bear Stearns and Lehman Brothers, which often do business in a much more aggressive fashion with less regulation.
Commercial banks and investment banks that deal in securities, once worlds apart, aren't really so different today. They have gotten into each other's businesses to such a degree that all the big banks look similar.
Their financial interests have also become interwoven to a much greater degree, making a problem at one bank an issue for another. Counterparties in financial transactions can tumble like dominos.
"The Fed's ultimate charge is to keep the banking system running," says Dan Fuss, manager of the Loomis Sayles Bond Fund. "Let's say they let Bear Stearns go. It's a counterparty to a lot of those other banks. It would not have been good news for JPMorgan. They're supposed to keep the banking system running and keep the rest of us gainfully employed. That's really their job."
So the Fed came to the aid of the securities business, which may or may not cost you, the taxpayer, in the long run. Of course, this is the same industry that has been most responsible for driving the real economy into apparent recession and possibly even greater danger ahead. Its actions weren't all malevolent, but rampant excess went unchecked by market discipline or anything else.
The Fed protects banks, but also subjects them to much greater supervision and regulation. What about Wall Street? The answer may depend on how expensive any bailout turns out to be and what kind of damage the economy ultimately suffers.
Risk is a big part of the securities business and always has been. Countless fortunes have been made and lost on Wall Street with bold action and borrowed money, all considered fair game. What we are experiencing today is different.
The Fed bailed out Wall Street and may have to do it again in the future. What will Wall Street have to give up in return?
Steven Syre is a Globe columnist. He can be reached at syre@globe.com.
