The US Federal Reserve has just done the one thing that central banks must steer away from at all costs—salvage private enterprise that has been brought to its knees by reckless trading. Such brash risk-taking is often led by little else than a desire to earn fat year-end bonuses for toptier bankers.
In the past week, as the drama at Bear Stearns unfolded, the one thing that has emerged clearly is that the Fed chief Ben Bernanke doesn’t have an iron stomach. As clients made a run on Bear Stearns, calling in nearly $17 billion, the Fed through JPMorgan held out a helping hand to a firm that in the past has scoffed at the idea of extending help to its peers in distress.
Without a doubt, some 14,000 jobs in banking could have been in jeopardy had the bank filed for bankruptcy protection. But it’s not the first time in American history that a firm would have turned around to stop the run by creditors and say it was in dire straits. Why, then, should the Fed treat Bear Stearns any differently from, say, an Enron, which went belly up earlier this decade? Of course Enron cooked its books, but it employed way more people than Bear Stearns did. And the people it employed touched common lives more with simple things such as power and gas.
The one thing different at Bear and scores of others, it seems for now, is that they took a wrong call on debt assets. Companies make and lose their fortunes based on practices good and bad—and decisions smart and foolish. So, if insurers and reinsurers who have underwritten banking risk cry out real loud, would Bernanke like to step in for them too?
If the Fed and, by default, the US government step in to shore up financial institutions, especially when retail money is not involved and small-time savers’ money is not at risk, it’s sending out a very tardy signal. Bear Stearns does no retail banking.
With this bailout, coupled with lending to primary dealers through its discount window, the Fed is being charitable to buccaneer traders and is helping preserve the lifestyles and cover the follies of the most overpaid earners of any industry.
Banking, we all know by now, is a game of creating wealth by fooling around with other people’s money, so any gains will pay for outsized banker-bonuses on Wall Street. And most losses, it seems, will be paid for by American taxpayers.
To be sure, the run on Bear Stearns was sentiment-driven and while its early losses were a result of bad calls, the run was inspired by the same bunch of clients who, while they profited in good times, are unwilling to play the game of high-risk and high-reward when the risk hits home.
To then give that community a buffer, while foreclosures of loans in the US are leading to abandoning of homes to sometimes burning them down to claim insurance, is the same as signalling that while governments care deeply about bankers in trouble, they can’t muster the same empathy for the common man. US President George Bush took care when he extended his government’s help to subprime borrowers, to show that the government was reluctant to interfere with free markets and free capital.
Overnight, though, the most powerful central bank in the world has sent out a message to other central banks in the world —that it’s okay to interfere with free enterprise and that they shouldn’t think twice about making the taxpayer pay for cowboy antics on the trading desk.
Unfortunately, it has also just let its most powerful argument slip out of its hands.
Anjana Menon is national editor (corporate). Comments are welcome at email@example.com