We are pleased to announce the arrival of SPERI Paper No.4. The paper entitled ‘How to Make a Bad Problem Worse: The US Federal Reserve’s Rescue of Bear Stearns’ is by Matthew Watson, Professor of Political Economy, University of Warwick.
When Bear Stearns, one of Wall Street’s fabled pre-crisis ‘big five’ investment banks, faced imminent collapse in March 2008, the Federal Reserve intervened. It blurred the boundaries of its own legal remit by using public money to help facilitate Bear’s purchase by the commercial bank, JPMorgan Chase. It did so to prevent increasingly worthless mortgage-backed securities from creating gaping holes in the balance sheets of the entire US banking industry. Yet the Fed’s actions also ran contrary to US regulators’ justification for their tolerance towards the complex derivatives that created the mortgage securitisation business in the first place: namely, that they provide the impetus for ‘market completeness’ by synthetically linking one financial market to another. Full market completion has been the objective of US lawmakers since the Gramm-Leach-Bliley Act of 1999 formally dismantled the Glass-Steagall ‘wall’ between investment and commercial banking activities, and stipulating the abstract conditions of full market completion has also been one of the most highly prized goals of pure economics since the seminal theoretical writings of Léon Walras in the 1870s. However, general equilibrium economics has never been able to provide a genuinely economic rationale for policies that push in the direction of market completion. Moreover, the Fed’s actions in using Morgan as a conduit for rescuing Bear have in practice merely complicated the matter further. They were presented as facilitating a market rescue that would prevent future financial crises from occurring, but they had the effect of allowing the largest banks to take the whole of the subprime securitisation cycle in-house. This in turn makes market-based checks and balances against the future inflation of subprime securitisation bubbles much less robust.
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