Bailing out Bear Stearns

ALEX COHEN, host:

From the studios at NPR West, this is DAY TO DAY. I'm Alex Cohen.

ALEX CHADWICK, host:

I'm Alex Chadwick. Our big story today is the economy and efforts to stabilize it. We're going to spend the first part of the program here.

COHEN: Let's start with the latest twist in the story on Wall Street this morning. The Federal Reserve took extraordinary action over the weekend to try to reassure shaky financial markets.

CHADWICK: This came after one of Wall Street's biggest investment banks - that's Bear Stearns - essentially collapsed over the weekend.

A rival bank, JP Morgan Chase will buy Bear Stearns for the price of two dollars a share. The Fed also cut its emergency lending rate by a quarter of a percent, an action that came a surprising two days earlier than expected.

COHEN: For more, we go now to NPR's Scott Horsley.

Scott, thanks for joining us, and tell us - the Fed working on a Sunday. What exactly are they up to?

SCOTT HORSLEY: That's right, Alex. This was unusual in a couple of respects. One is they did take this action over the weekend. As Alex says, they had a regularly scheduled meeting set for tomorrow, but they didn't want to take the risk of waiting that long to act.

In addition, they're opening the discount window. That's the loans they'll make directly to banks, but not just to commercial banks as usual but also to securities dealers, which is something they haven't done since the Great Depression. The Fed is trying to prevent the credit crunch from turning into a complete credit freeze.

COHEN: And the Fed says it wants to maintain the orderly functioning of financial markets, but it seems, Scott, that there was nothing too orderly about the collapse of Bear Stearns.

HORSLEY: No, this was really a spectacular meltdown. Bear Stearns, one of the biggest investment banks on Wall Street, 85 years old. Last week there had been rumors that the bank was in trouble and on Friday it had to get a lifeline from JP Morgan Chase and the Fed. Its stock lost about half its value on Friday and most of the rest over the weekend. It was really a stunning collapse.

What we saw with Bear Stearns was really a classic run on the bank. I mean, you can picture Jimmy Stewart there in the savings and loan trying to fend off nervous depositors. Only with Bear Stearns it wasn't depositors; it was trading partners and hedge funds that were getting nervous about doing business and its cash just pretty much evaporated. And by late Friday it was teetering on the brink of bankruptcy.

COHEN: So how does the Fed hope to fix this?

HORSLEY: Well, the Fed has, first of all, approved the takeover of Bear Stearns by JP Morgan Chase. It approved the financing, and in fact the Fed is backstopping JP Morgan's purchase and guaranteeing some of Bear Stearns' business. So essentially the taxpayers are on the hook to some extent in this takeover and may pay a price for some of Bear Stearns' bad debts. But the Fed just felt like they couldn't take the risk of having Bear Stearns, which has hooks in so many corners of the financial market, not just go bankrupt but go bankrupt so quickly. That would have caused just unknowable trouble.

COHEN: The credit crunch, of course, began with the meltdown of the subprime mortgage market. Is this still all about mortgages or is there something else at play?

HORSLEY: What it really is is a loss of liquidity, and that means not just the volume of money that's floating around the financial markets but also confidence. The financial writer Jim Grant once described liquidity as the expectation that everything will go right. And that's really the way the credit markets were functioning not so awful long ago. That's why banks were willing to make these risky loans to subprime borrowers.

Now that has all turned around. The pendulum has swung. People no longer expect everything to go right. They're worrying about what might go wrong, and there's a big financial gut check going on. Some of that is healthy, but if the credit dries up too much, too fast, the gut check becomes a bleeding ulcer. And that's what the Fed is trying to prevent here.

COHEN: NPR's Scott Horsley.

Thanks, Scott.

HORSLEY: My pleasure. Transcript provided by NPR, Copyright NPR.