Fed’s action in Bear Stearns's near collapse could signal new phase in credit crunch
“No longer is the Fed simply pumping money into the economy to promote lending. It is now putting taxpayers on the hook for investments of uncertain value and extending federal help to Wall Street firms whose activities haven’t been regulated as closely as commercial banks,” the editorial said, calling the Fed’s actions extraordinary.
The storied Bear Stearns, once the country’s fifth-largest investment bank, was in trouble because its investors no longer believed it could repay its loans, even loans for short terms including overnight, reported USA Today. Investors concluded the bank was no longer able to stand behind the complex agreements it had with other banks, investment houses, and corporations.
“As far as Wall Street securities houses go, Bear Stearns wasn’t too big to fail,” Steve East, chief economist for FBR Capital Markets, told USA Today. “It was too interconnected to fail.”
The housing bubble was the catalyst for Bear Stearns’ problems as banks loaned money to people who normally wouldn’t qualify for conventional mortgages. Wall Street bought these subprime mortgage loans and mixed them with other types of debt and created complex investments, which were sold to investors. That process worked until the economy worsened and people who had borrowed money began to default on payments. Bear Stearns has been described as one of the biggest underwriters of complex investments tied to mortgages. Deloitte & Touche warned investors that more than 60 percent of the net worth of two Bear Stearns’ hedge funds was tied up in exotic securities, according to Businessweek. The Deloitte & Touche 2006 audit was released in May 2007.
“The hedge funds were built so they were virtually guaranteed to implode if market conditions turned south,” according to a Businessweek analysis of confidential financial statements for both funds and interviews with forensic accounting experts, traders, and analysts.
The Los Angeles Times said the innovations that helped extend credit to more borrowers are now showing “a flip side that asleep-at-the-switch regulators and policymakers didn’t anticipate.”