Fed Takes Rare Path to Aid Bear Stearns

03/28/2008 05:12 am ET | Updated May 25, 2011

WASHINGTON — The Federal Reserve invoked a rarely used Depression-era procedure Friday to bolster troubled Bear Stearns Cos. and said it will provide even more help to combat a serious credit crisis.

The action won praise from the administration, with President Bush saying that Fed Chairman Ben Bernanke was "doing a good job under tough circumstances."

The Fed announcement came in a brief two-sentence statement that was issued as stocks were plunging on Wall Street over worries that a plan to ease a liquidity crisis at Bear Stearns Cos. might not work. Federal Reserve Chairman Ben Bernanke, delivering a speech later Friday, told a housing group he had had a "busy morning." He did not elaborate on the Fed's action regarding Bear Stearns.

"The Federal Reserve is monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system," the board said in its statement. It said members had voted unanimously to approve the arrangement, announced by JP Morgan Chase and Bear Stearns earlier.

Delivering a speech on the economy in New York, Bush voiced confidence in the Fed's actions to aggressively cut interest rates and the Fed announcement last week that it would supply up to $200 billion in loans to cash-strapped financial institutions.

"It was a strong action by the Fed and they did so because some financial institutions that borrowed money to buy securities in the housing industry must now repair their balance sheets before they can make further loans," Bush said. "Today's actions are fasting moving, but the chairman of the Federal Reserve and the secretary of the treasury are on top of them and will take the appropriate steps to promote stability in our markets."

The plan announced Friday will supply secured funding to Bear Stearns for an initial period of 28 days, seeking to provide short-term relief for Bear Stearns.

Senior Federal Reserve staffers said the arrangement allows JP Morgan Chase to borrow from the Fed's discount window and put up collateral from Bear Stearns to back up the loans. JP Morgan, a bank, has access to the discount window to obtain direct loans from the Fed, but Bear Stearns, an investment house, does not.

While JP Morgan is serving as a conduit for the loans, the Fed and not JP Morgan will bear the risk if the loans are not repaid, officials said.

This type of procedure, Fed officials said, dates back to the Great Depression of the 1930s but has rarely been used since that time.

In his speech, Bush said the administration had a plan to deal with the problems in credit and housing markets and said he opposed a number of measures pending in Congress to go further by allocating billions of dollars to purchase abandoned and foreclosed home and changing the bankruptcy code to allow judges to adjust mortgage terms.

However, Senate Banking Committee Chairman Christopher Dodd, D-Conn., said the problems at Bearn Stearns, one of the country's largest investment banks, highlighed the need for more aggressive efforts.

"Instead of cheerleading and reacting with tepid measures, the administration should act boldly and decisively to prevent the looming foreclosure crisis from having catastrophic consequences for our economy and our markets," Dodd said in a statement.

Treasury Secretary Henry Paulson praised the Fed's leadership and said that the country's financial system would be able to weather the problems.

"As we have been saying for some time, there are challenges in our financial markets and we continue to address them," Paulson said in a statement. "This is another challenge that market participants and regulators are addressing. We are working closely with the Federal Reserve" and the Securities and Exchange Commission.

Paulson said he appreciated the leadership of the Fed "in enhancing the stability and orderliness of our markets."

The action by the Fed board in Washington represented an endorsement of a rescue effort for Bear Stearns that had already been arranged by JPMorgan and the Federal Reserve's New York regional bank.

It was seen as a last-ditch effort to save the investment bank, which on Friday acknowledged its serious financial problems after a week of denials.

After the situation at Bear Stearns worsened late Wednesday, there were a series of conference calls throughout the day on Thursday with officials from the Fed, the New York Fed and the SEC to assess the potential impact on the broader economy, according to a Treasury official, who spoke on condition of anonymity because of the sensitive nature of the discussions.

This official said that Paulson had been keeping Bush updated on the proposed rescue effort.

JPMorgan Chase is providing an undisclosed amount of secured funding to Bear for 28 days, backstopped by the Federal Reserve Bank of New York.

The Securities and Exchange Commission issued a statement saying it has been "in close contact" with Treasury, the Federal Reserve and the Federal Reserve Bank of New York during discussions concerning an agreement by J.P. Morgan Chase & Co. to provide a secured loan facility to The Bear Stearns Companies.

"We will continue to work closely together in a way that contributes to orderly and liquid markets," the SEC said.

Last week, the Fed announced an industry-wide rescue package that would provide as much as $200 billion in loans to banks and investment houses and allow them to put up risky home-loan packages as collateral. It was the Fed's latest effort to stem a global credit crisis that began last August with rising loan defaults for subprime mortgages, loans provided to borrowers with weak credit histories.

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Associated Press reporters Marcy Gordon, Jeannine Aversa, Terence Hunt, Stephen Bernard, Madlen Read and Joe Bel Bruno contributed to this report.

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