For the moment, everybody is advocating patch and mend. The resistance to thinking big extends even to denying the significance of steps already taken. For example, a bright line has been drawn by the Fed, the Treasury and by others between liquidity support for stressed financial companies and the outright taxpayer-funded purchase of impaired assets.
In fact, despite efforts to disguise it, the Bear Stearns operation has already crossed that line.
The Fed is now the de facto owner of $29bn (£15bn) of mortgage-backed securities – in the sense that, upon liquidation of the assets, it bears any losses and keeps any profits. Getting with the times, it has even created an off-balance-sheet vehicle to manage these dud assets and is camouflaging this underlying reality behind Bear’s new owner, JPMorgan, and talk about “loans”. In all but name, the Fed has nationalised the Bear Stearns portfolio of mortgage-backed securities. If a big principle was at stake in this, it has already been flouted – just as with Northern Rock. Whether the cosmetics of the Fed’s move will subtract anything from calls for transparency in financial dealings (when carried out by the private sector, that is) will be interesting to see.
The sensitivity of the Bear Stearns operation, of course, is tied up with concerns about moral hazard. Repeat after me: you encourage recklessness if you protect people from its consequences. The debate about future financial regulation continues to be framed around this concept: safety nets imply supervision because of moral hazard. This maxim is true enough, but I doubt that it gets at the crux of the current problem.
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