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    Roubini on the Bear Stearns Bailout

    03/19/2008

    NYU Professor Nouriel Roubini is an outspoken pessimist on the health of the financial system, and I don't agree with all of his policy ideas.  No matter, he nails it with this explanation of the Federal Reserve/JP Morgan Chase/ Bear Stearns deal last weekend:

    Claiming the Bear Stearns was not bailed out because the current shareholders got only $2 per share is disingenuous: this was a massive bailout as the Fed put $30 billion of cheap credits in the pot: without this massive financial support not only the shareholders would have been wiped out 100% as they deserved to (rather than keeping the option value that the government support will recover in due time the value of their shares); but also many of the creditors of Bear Stearns would have experienced massive losses as Bear was insolvent and unable to pay such creditors with its impaired assets. Instead the $30 bn Fed support represents a major subsidy for JPMorgan and a major bailout of Bear’s creditors. Effectively the Fed has taken on its balance sheet the entire credit risk of $30 of toxic securities held by Bear Stearns.  So, this Fed bail out is an explicit case of using the disastrous Japanese model of a “convoy system” (healthier banks taking over zombie banks with the help of lots of public money) that led to a decade of economic and financial stagnation.

    America crossed a line last Sunday, and the costs and scope of the damage (to taxpayers and to the financial system in the form of moral hazard) may not be fully understood for some time.