Fed Helps Big Firms to Prevent Financial 'Contagion'

Fed: Emergency help for Wall Street was necessary to avert "contagion" of financial system.

The Federal Reserve was scrambling to prevent a "contagion" from infecting the nation's financial system when it took unprecedented actions to back a Bear Stearns rescue package and provide emergency loans to big Wall Street firms.

The Federal Reserve released documents Friday providing insights into its private deliberations in March that led to those controversial decisions. The Fed's actions came when credit and financial problems were intensifying, threatening to paralyze the entire financial system and plunge the economy into a recession.

Given the financial markets' fragile condition at that time, the Fed said it felt compelled to intervene because an "immediate failure" of Bear Stearns would bring about an "expected contagion."

Fed Chairman Ben Bernanke and his colleagues initially moved on March 14 to provide temporary emergency financing to investment bank Bear Stearns Cos. through an arrangement with JPMorgan Chase & Co. Two days later, as the nation's then-fifth-largest investment bank teetered on the brink of bankruptcy, the Fed agreed to provide backing for up to $30 billion for a deal in which JPMorgan would take over the troubled company.

That same day -- March 16 -- the Fed said it would let big Wall Street firms go directly to the Fed for emergency loans, a privilege only commercial banks had previously enjoyed. It was the broadest use of the Fed's lending powers since the 1930s.

The Fed's decision to take this action was "based on recent, rapidly changing developments," the documents said. "These developments demonstrated that there had been impairment of a broad range of financial markets" that Wall Street firms rely on for financing.

There was fear that other Wall Street firms could fall into jeopardy, sending problems cascading through the financial system. Democrats in Congress and other critics contend the Fed's actions are akin to a government bailout and are putting billions of taxpayer dollars at risk.

However, Bernanke has defended the actions, and in appearances on Capitol Hill has said he doesn't believe taxpayers will suffer any losses. The Fed's financial lifeline in JPMorgan's takeover of Bear Stearns was subsequently changed to $29 billion and -- most recently -- to $28.82 billion.

The documents said the Fed, in discussions on March 16, believed the takeover -- and the Fed's involvement in helping to bring it about -- were "necessary to avoid serious disruptions to financial markets." The Fed said "many potential investors" had been invited to back Bear Stearns but the investment firm determined that JPMorgan was "the most suitable bidder."

Bear Stearns began to unravel last year when two hedge funds it managed collapsed because of heavy bets on subprime mortgage securities, which soured when the housing market fell into a deep slump. Along with other big investment banks, it was forced to take multibillion-dollar writedowns on the bad investments. Then rumors in mid-March about the company's cash position triggered a run on the investment bank that left it close to bankruptcy. Earlier this month, JPMorgan closed its acquisition of Bear Stearns, bringing to an end an 85-year-old institution.