Andre J. Peschong

It seems that everyone I talk to on Main Street is all concerned and angst ridden towards the government’s bailout of Bear Stearns.  They are angry because they believe the government is supporting big business and even worse, they are supporting Wall Street big business.  It is interesting to hear an everyman’s perspective on something that is so extremely complex and has ramifications that the brightest in the financial community cannot really fathom yet.  This is a very polarizing issue and one that probably has been brought to the surface because of the weak and uncertain economy coupled with election year upheaval. 

What people fail to understand is that the government cannot let Bear Stearns fail!  Why?  It would literally be a massive domino effect that has the potential to lay waste to the fabric of our capital/free market system.  Elizabeth MacDonald at Fox Business explains it well in her article: The Brinkmanship at Bear Stearns.  To put that last statement into perspective the US government issues bonds which have the highest rating possible. What are these bonds backed with?  The answer is nothing but the full faith of the United States government.  What happens if the people lose faith in government, which means the world loses faith that means the bonds tumble, the US credit rating sinks, and we see the dreaded domino effect.

In the case of Bear Stearns, they were utilizing yield enhancements, which is a fancy phrase for using leverage, and a lot of it, with the CDO products (Collateralized Debt Obligations). This is not an unusual practice, as most hedge funds implement yield enhancements. However, the sheer amount of CDO’s that Bear Stearns was holding as not only a principal but also as a clearing firm and a prime broker for other hedge funds was staggering.  Additionally,  the amount of leverage used was enormous. 

As a result,  basic supply and demand issues really came to play in the governments’ decision for a “bailout”.    If the government had not guaranteed the Bear Stearns debt for JP Morgan’s buyout offer then the deal never would have taken place. Bear Stearns would have gone into liquidation, which would have literally dumped the assets of the company onto the street where buyers were extremely scarce to begin with.  This devastating domino effect would have led to a complete meltdown in the mortgage securities market which would have dumped a massive amount of foreclosures onto an already saturated real estate market thus compounding the pain to individuals and so on and so on… you get the idea.  Sometimes discretion is the better part of valor.  If in fact there was no quick and decisive decision by the Fed to guarantee the debt the hardworking people on the street would have suffered the most.  There  would potentially have been a run on banks, companies folding because of no liquidity, housing prices plummeting to all time lows and unemployment rates exceeding 10- 15%. 

What the Bear Stearns “rescue” has really done is allowed the government to come into these massive investment companies with more rules and regulations similar to the Glass-Steagall Act in the banking sector.  This will create more bureaucracy but in the long run should minimize another potential domino effect.  History has given us some lessons…we should learn from them. 

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