Friday, March 14, 2008

Fed Bailout of Bear Stearns

The Fed is behaving like the lender of last resort by providing funds to bailout a sinking Bear Stearns. This crisis has moved beyond issues of moral hazard from using public funds to bailout a private firm. Funds are necessary to maintain the integrity of the financial markets. The Fed is using its authority to lend to a non-bank entity through a special vote of the Board of Governors. The Fed pledged to "continue to provide liquidity as necessary to promote the orderly functioning of the financial system". The credit was extended through JP Morgan.

The stock market has seen increased volatility and has sold off hard even after economic news that was slightly better than expected. The problem is now determining what to do with Bear Stearns. Once liquidity to a dealer dries up there is little that can be done to save the firm. The only option is for some form of orderly liquidation of positions and there usually little that is orderly during a market sell-off.

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