Congress Grills Bernanke Over Bear

Federal Reserve Chairman Ben Bernanke and company offered Congress a detailed explanation yesterday for March's unprecedented rescue of Bear Stearns (NYSE: BSC  ) . Regulators, politicians, and Wall Street executives alike provided flattering portrayals of their own roles in the episode, and a good time was had by all -- except, perhaps, the taxpayers.

Recapping the rescue
On the weekend of March 15-16, Bear Stearns realized it would be unable to remain solvent and notified the Federal Reserve, which in turn called on JPMorgan Chase (NYSE: JPM  ) . Over that weekend, the Fed helped craft a deal for JPMorgan to buy Bear Stearns for $2 per share; in exchange, the federal government would provide JPMorgan $30 billion (now $29 billion) in loan guarantees. This unusual activism by the Federal Reserve set off a whirlwind of debate, culminating in yesterday's hearings.

Needless bailout or necessary intervention?
The hearings mainly involved a back-and-forth between Congress's chief concern and the Fed's chief justification. Senate Banking Committee Chairman Chris Dodd asked the hearing's central question: "Was this a justified rescue to prevent a systemic collapse of the financial markets, or a $29 billion taxpayer bailout for a Wall Street firm?" Dodd and other politicians seemed less than enamored of using taxpayer money to save profiteering executives who deserved to fail, especially while millions of Americans struggle to pay their mortgages.

Bernanke argued that the repercussions of a Bear bankruptcy would have likely included higher interest rates, more restrictive credit, and market havoc that would have damaged Main Street and Wall Street alike. For one thing, a Bear bankruptcy might have triggered a run on other banks, such as Lehman Brothers (NYSE: LEH  ) and Morgan Stanley (NYSE: MS  ) .

I did everything I could
Wall Street executives weighed in as well. James Dimon, CEO of JPMorgan Chase, agreed with regulators' assessment that a Bear Stearns bankruptcy would have "added to the financial crisis." Ongoing subprime woes have already led to catastrophic write-downs by Citigroup (NYSE: C  ) , Merrill Lynch (NYSE: MER  ) , and UBS (NYSE: UBS  ) .

Snapping up a company with $80 per share in book value for a mere $10 per share might seem like an outrageously good deal. But Dimon's testimony suggested that Bear Stearns' economic liabilities made the buyout a much riskier move for JPMorgan, and that his company acted selflessly in hopes of shoring up the financial sector.

Bear Stearns President and CEO Alan Schwartz suggested that without the rescue plan, his investment bank would have declared bankruptcy. He also recounted how the liquidity rumors that permeated the markets in the days before Bear's demise became a self-fulfilling prophecy, spooking clients into withdrawing their money. While this is likely true, Schwartz neglected to mention the astronomical amounts of leverage the firm assumed during the housing bubble, hoping for hefty profits that he and other top executives would likely have enjoyed.

Where do we go from here?
When the dust settles, I think Congress and history will find that the Fed's actions did prevent worse damage to the economy, however dangerous the precedent. Expect politicans and regulators to call further attention to how Wall Street got into its present mess in the coming months.

In the end, those in favor of increased regulation will argue that Wall Street executives gorged themselves on easy and cheap profits, and almost destroyed the economy. Therefore, regulation proponents will argue, we need to keep an eye on these guys so they don't do it again.

Opponents will counter that banking is already one of the most heavily regulated industries. If regulation were such a good thing, we wouldn't be in this mess. They may also note that the subprime crisis was largely caused by Alan Greenspan's creation of artificially low interest rates that a free market would not otherwise have.

In short, Fools, we are in for an interesting debate.

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