The Bear Precedent
If the Federal Reserve hadn't arranged the sale of Bear Stearns and taken over responsibility for its most questionable securities, the company likely would have had only one avenue as it ran out of operating cash late last week: bankruptcy.</br></br>That bankruptcy would have been painful, sending new waves of distrust through the financial system and likely forcing Bear's counterparties to book reserves for losses. But even in a world of bad choices, there's always a worst choice. And the Fed, by being so quick to jettison the bankruptcy process, cut off a valuable source of new information to financial markets and blurred the critical distinction between sophisticated and unsophisticated investors.</br></br>True, a Bear bankruptcy would be a mess. To get an idea, pull up one of the Enron bankruptcy spreadsheets from six years ago: creditor after creditor listed on page after page, with amounts owed from a few hundred dollars to hundreds of millions each.</br></br>A Bear bankruptcy would also have caused shocks through the financial system. Institutional investors would have to rethink whether or not they trust the party on the other side of each of their trades, particularly in the opaque derivatives market. ("Is the company good for the money?") Hedge funds, and other personal and institutional clients, would have to worry about who has actual custody of their accounts.</br></br>And so, to avoid those shocks, the Fed has done something unprecedented. It has provided $30 billion in guarantees behind Bear's most complex, illiquid securities, so that the much larger and more secure J.P. Morgan Chase & Co. would be willing to buy the company for $2 a share.