Capital Markets

Bernanke Justifies Rescue of Bear Stearns

The Fed chairman contends that Bernanke explained that the investment bank was too big to fail.
Alan RappeportApril 3, 2008

Federal Reserve Chairman Ben Bernanke reiterated on Thursday his rationale for orchestrating the $30 billion bailout of Bear Stearns last month: a disorderly failure would have had severe consequences for the broader economy.

The rescue, coordinated with J.P. Morgan Chase & Co., has drawn criticism from skeptics who contend that the bank —not taxpayers —should have paid for its mistakes. They have also argued that government bailouts create “moral hazard,” that is, an incentive for the rescued company to persist in its reckless behavior.

Speaking before the Senate Committee on Banking, Housing, and Urban Affairs, Bernanke explained why Bear Stearns was, in effect, too big to fail. “Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain,” Bernanke said. “The adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability.”

Bernanke also gave a downbeat assessment of the economy, noting that, despite some improvements, financial markets remain under “considerable stress.” He said the stressors include the recent scarcity of credit, the hefty losses facing banks, and failures in nonconforming mortgages and other underlying risks in securitization markets. Further, he acknowledged that the near-term economic outlook was bleaker than projected at the end of January and that inflation remained a concern.

Defending the board’s recent moves to inject more liquidity into the financial markets and aggressively slashing interest rates, he suggested that the worst might be over. “Clearly, the U.S. economy is going through a very difficult period,” Bernanke said. “Much necessary economic and financial adjustment has already taken place, and monetary and fiscal policies…should support a return to growth in the second half of this year and next year.”

Bernanke was joined by Christopher Cox, chairman of Securities and Exchange Commission, who argued that Congress should act to improve oversight of investment bank liquidity. He said that the SEC’s responsibility for regulating investment banks focuses primarily on ensuring that those firms can survive for at least a year without unsecured funding.

Also testifying before the committee was Treasury Undersecretary Robert Steel, who maintained that the regulators handled the Bear Stearns situation correctly. “The Treasury Department supports the actions taken by the Federal Reserve Bank of New York and the Federal Reserve,” Steel said. “We believe the agreements reached were necessary and appropriate to maintain stability in our financial system during this critical time.”

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