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The Fed's risky business

By William F. Shughart II
April 11, 2008

Before being appointed Federal Reserve Board chairman, Ben Bernanke was known best in academic circles for his work on the Great Depression. Mr. Bernanke concluded from his studies that America's economic recovery was due largely to the aggressive actions of President Franklin D. Roosevelt:

"Many of his policies did not work as intended but in the end, FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done."

While more recent scholarship suggests the opposite — that Roosevelt's New Deal both deepened the downturn that began before the October 1929 stock market crash and prolonged the nation's economic miseries — Mr. Bernanke's recent efforts to deal with the looming financial crisis and credit market meltdown are reminiscent of his hero's. Mr. Bernanke's first act was to announce a $200 billion line of credit for cash-strapped commercial and investment banks, which would allow them to borrow Treasury securities using risky mortgage-backed securities as collateral.

He then repeated the offer to brokerage houses. Within days, Goldman Sachs, Lehman Brothers, Morgan Stanley and other Wall Street giants had taken out $28.8 billion in new loans.

The Fed's next move was to arrange JPMorgan Chase's purchase of Bear Stearns for the bargain-basement price of $236.2 million (later sweetened to $1.2 billion) by guaranteeing $29 billion worth of Stearns' illiquid assets.

As Mr. Bernanke should know, this is not the first time the federal government has rescued private businesses. And as he also should know, government bailouts are risky business.

During his famous First Hundred Days, Roosevelt signed a law creating the Home Owners' Loan Corp. to refinance mortgages, relieving pressures on Depression-battered homeowners who could not make their monthly payments and on the banks that lent them the money.

The credit crunch of the early 1930s, a time before deposit insurance, was precipitated by runs on commercial banks by customers worried about the safety of their life savings. The financial crisis of 2008 is starkly different. There is no need to restore public confidence in bad business decisionmaking.

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