Bear Stearns Bailout Corporate Welfare

Some will rob you with a six-gun; and some with a fountain pen.

It's been said of U.S. economic policy that a rising tide floats all yachts. Last week, J.P. Morgan Chase offered to buy Bear Stearns for a fire-sale price that didn't cover the value of the real estate involved, with the backing of the federal government. This week, J.P. Morgan Chase increased its offer to a whopping $10 per share, after Bear Stearns employees, who own close to a third of the company threatened a class action lawsuit.

As part of the deal, the federal government agreed to guarantee $30 billion worth of subprime mortgage debt to facilitate the takeover. BlackRock Financial Management, a for-profit corporation, will handle the mortgages, and the American taxpayer will pay for the rescue with a weakened dollar and higher prices. The proof: treasury bond prices fell with the announcement of the scheme, even while Wall Street rallied.

The reasoning behind all the deal-making and jockeying is that it is necessary to prevent millions of Americans from losing their homes and that the collapse of a company like Bear Stearns would rock the market to its foundations. Neither position is entirely true. There were and still are other ways of dealing with the subprime mortgage market problem that do not involve government heroics.

While it is true that millions of people are in danger of losing their homes, it is not true that those who hold the mortgages have to foreclose. People who borrowed too much money on adjustable-rate-mortgages and now cannot meet their obligations made a bad financial decision, without a doubt. But the lenders who marketed the mortgages to them without regard to their ability to pay share the blame. While neither borrowers nor lenders are innocent in the situation, the banks are guilty of a short-sightedness that the free market so dear to Americans cannot tolerate.

Investment banks are unwilling to bear the burden of their bad investments, for that is exactly what these are. Neither are they willing to face their choices. While the logical consequence of not paying one's debt is repossession of the asset by the creditor, it is not the only solution, nor in this case, the best solution for either debtor or creditor. More reasonable, if less glamorous, solutions are available.

Companies that hold home mortgages are not bound by law to foreclose if the borrower becomes unable to pay on time. They are free to renegotiate the terms of the notes with the borrowers, lower interest rates, or change the length of the note in order to protect their investments. Doing so would certainly have an impact on the value of company assets, but hardly the same kind of impact millions of foreclosures would have. The creditors could recover their investments at a lower rate of interest or over a longer term, or both, rather than become the owners of real estate that they can't sell. Such a renegotiation has a further advantage of leaving the value of the dollar intact.

The investment bankers, however, would prefer that the federal government cover their bad decisions. In the event that these companies were required to sort out the mess they themselves had created, their CEOs would almost certainly have to account for their bad decisions and perhaps even be chastised for them with compensation cutbacks and loss of bonuses. Therein lies the problem.

Using the threat of millions of foreclosures and its consequences on the economy, a rescue backed by the Fed allows the high-fliers to walk away from the consequences of their actions with their personal wealth intact. No other solution will be quite so attractive as long as this is the case.