No straight talk here
How's this for a pile of flat-out lies? "Alan Schwartz, President and CEO of The Bear Stearns Companies Inc., said, 'Bear Stearns' balance sheet, liquidity and capital remain strong.'"

That was one week ago. Today, we woke up to the news that the Federal Reserve worked all weekend to negotiate a last-minute buyout of Bear Stearns (NYSE: BSC) by JPMorgan Chase (NYSE: JPM) for the fire-sale price of $2 a share. Bear traded for as much as $170 a stub last year, so this ranks as one of the most amazing falls in Wall Street history.

Econ 101, anyone?
But it was all too predictable. Bear ranked in the top echelon of Wall Street banks that packaged mortgages into complex securities and sold them to other investors, who often chopped them into even more complex, more highly leveraged securities, and sold them to yet another crop of investors.

Investors? Make that "suckers."

By now, we know just how risky these securities were. They didn't eliminate risk. They obscured it, and it infected the entire banking system. They were based on models that assumed that home prices would continue to rise -- thus freeing lenders from the pesky job of having to decide whether borrowers actually had the cash flow to make their payments. That hasn't panned out.

As overstretched borrowers began to realize there was no way to refinance out of their mortgages, they have stopped paying -- and not just on subprime loans. As default rates accelerate -- and we're seeing only the beginning -- these securities have become increasingly worthless, even as parts of them were pitched as triple-A by complacent rating agencies such as Moody's (NYSE: MCO) and McGraw-Hill's (NYSE: MHP) S&P.

When pyramid schemes crumble
The ensuing devaluation of these debt securities has caused a ripple effect through banks as they have to shore up their capital structure and find themselves unable to offload the opaque monsters they created. Few are willing to buy the pig in the proverbial poke -- except, of course, Federal Reserve Chairman Ben Bernanke.

And that's why JPMorgan bought Bear Stearns. Bernanke -- who can print as much money as he wants and stick taxpayers with the bill -- had to sweeten the deal by guaranteeing $30 billion in Bear's lousy assets. Which ones? No one knows. According to The Wall Street Journal, the Fed won't say. So not only does JPMorgan get Bear's potentially valuable brokerage business, building, and other goodies, but it also has a nice big comfy cushion against loss, all provided by you and me.

Won't someone please think of the children!
Defenders of this decision will argue that Bear was "too big to fail" and that an ensuing panic would have taken down all of Wall Street. There might be something to that story. Or it might just be a great way to scare the masses into giving grudging support to a program of Wall Street welfare. "It's for your own good!" How else can the defenders spin a plan that will require billions of taxpayer dollars to pay for the egregious errors of Wall Street's best-paid "capitalists"?

Of course, this isn't helping investor confidence. Take a look at the market today, and late last week. We're already in panic mode. Lehman Brothers (NYSE: LEH) is on the ropes now, and even invincible Goldman Sachs (NYSE: GS) is rumored to be preparing a $3 billion writedown. How much is the Fed going to offer them, or their white knights, if the going gets even tougher?

Foolish final thought
If Bernanke, Hank Paulson, and the rest of our government's Wall Street Super Friends really believe in free markets, they'll make sure that companies are allowed to fail, especially when they richly deserve it, as Bear did. And if they need to step in and prop up certain, select businesses to shore up the system, they should make sure that the people doing the bailout -- we taxpayers -- get a potential payoff for their largesse. Why should JPMorgan get such a sweet deal with the rest of us holding the bag on the risk?

Privatizing profits and socializing losses is no way to run an economy. I wonder whether Bernanke learned that in grad school.

More Foolishness:

JPMorgan Chase is an Income Investor recommendation. McGraw-Hill and Moody's are Inside Value recommendations. Moody's is a Stock Advisor pick.

At the time of publication, Seth Jayson, a top-10 CAPS player, had no position in any company mentioned here. See his latest CAPS blog commentary, and view his stock holdings and Fool profile. Fool rules are here.