The Nation's Pulse

The Fed Panics

Its Bear Stearns bailout was indefensible -- and hazardous to the future of the free market.

By 3.18.08

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The extraordinary intrusion into the free market over the past several days by the Federal Reserve Board under Chairman Ben Bernanke should send shudders down the spines of conservatives everywhere.

While some so-called free marketers were lauding the Fed's bailout of Bear Stearns as a necessary rescue of a banking institution that was too connected with the rest of the financial system to be allowed to fail, government should not protect Wall Street firms from the inherent risks of investing.

As a result of the deal, American taxpayers could be on the hook for billions of dollars in troubled mortgage assets so that Bear Stearns can avert bankruptcy.

J.P. Morgan Chase is the main beneficiary of the Fed's corporate welfare. If Bear Stearns's shareholders approve the deal, J.P. Morgan will have purchased the bank for $2 per share in stock, even though shares closed at $30 just last Friday -- a bargain given that the Fed will absorb the risk.

No wonder J.P. Morgan shares jumped more than 10 percent yesterday, even though traditionally when acquisitions are announced the stock of the purchaser declines because its shares are being diluted.

ON TOP OF BAILING OUT Bear Stearns, the Fed cut a key interest rate (more rate cuts could come today), and extended lower borrowing rates to securities dealers for the first time since the 1930s. Taken together, all of the actions represent the Fed's attempt to shield the market from the consequences of costly mistakes for which it should bear responsibility.

Such a policy is potentially dangerous. In the 1990s and into this decade, the Japanese economy stagnated in the wake of the bursting of the nation's real estate bubble. Part of the problem in that crisis was that the government would not allow big banks to fail, and thus inadvertently caused them to make riskier loans.

The Fed's actions will also give advocates of big government another argument to use against free marketers. If taxpayers end up footing the bill when Wall Street banks get into trouble, they will ask, why shouldn't the government be able to impose more regulations on them preemptively?

And if we'll spend billions of dollars to save wealthy bankers, why can't we afford to take care of average families?

Writing in the New York Times on Monday, Paul Krugman acted like like the parent of a child who disobeyed instructions to wear a coat on a cold winter day, only to return to mommy and daddy sick and in need of care. "Between 2002 and 2007, false beliefs in the private sector... led to an epidemic of bad lending," Krugman explained.

Speaking at the liberal "Take Back America" conference in Washington, D.C. on Monday, Rep. John Conyers (D-Mich.) seized on the news of the Fed rescue plan as part of a call for socialized medicine.

Conyers mocked the idea that the government had just bailed out Bear Stearns, "the worst single predator in the financial system," and yet still expected the 47 million Americans who don't have health insurance to take more responsibility.

LOST IN ALL OF THIS is that the Federal Reserve Board itself is partially to blame for the current crisis. In the aftermath of the Sept. 11 attacks, then Fed Chairman Alan Greenspan was eager to avoid a recession. While at first it may have been prudent to cut interest rates, Greenspan went on one of the most aggressive rate-cutting campaigns in the history of the Fed, and mortgage rates tumbled to historic lows.

The lowering of rates is what triggered the housing boom that helped spur economic growth for several years, but that later became the source of many of the nation's current economic problems.

This, of course, is not to take blame away from mortgage lenders who were so eager to maintain their staggering growth rates that they lowered their lending standards, banks such as Bear Stearns that invested in derivatives of these subprime loans, or borrowers who purchased homes they clearly couldn't afford.

(Fraud is one thing, but for the life of me, I still cannot figure out how anybody could agree to take out an adjustable rate mortgage during a period when interest rates were at the lowest levels since the Eisenhower era and claim to be surprised when their rate goes up.)

What should most concern conservatives about the Fed's actions under Bernanke is that they represent another stage in the development of a society that does not ask anybody to take responsibility for its actions.

It no longer matters what anybody or any business did to find themselves in their current predicament. All that matters is that they have a grievance big enough or pervasive enough to move the government to action. Eventually, something has got to give.

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About the Author

Philip Klein is The American Spectator's Washington correspondent. You can follow him on Twitter at: http://twitter.com/Philipaklein