This is an archived article that was published on sltrib.com in 2008, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.
If you make a bad investment, you've got to take your lumps. Call it Finance Rule No. 1.
When the Federal Reserve rushed to loan Bear Stearns $29 billion after a run on the Wall Street investment bank, it undercut Rule No. 1. That makes us nervous.
The reason is simple. If you give investors the idea that the taxpayers, through the Federal Reserve, are going to bail them out when they make bad financial decisions, you encourage bad financial decisions. Greedy people then take ridiculous risks, and the cycle worsens.
Ben Bernanke, chairman of the Fed, told Congress the other day that the $29 billion loan that made it possible for J.P. Morgan Chase to acquire Bear Stearns was not a bailout. So what would he call it?
We concede, while asking this, that Bear Stearns investors and employees certainly have paid dearly for the firm's mistakes. But as Jonathan Macey of Yale University pointed out in The Wall Street Journal, the Fed does not and should not have the authority to bail out an investment bank like Bear Stearns. It is not a federally insured depository institution, after all, and has not paid into the system that provides that insurance.
The federal deposit insurance system, according to professor Macey, never anticipated this kind of Fed action. Rather, it was created to protect small depositors in commercial banks, not the big financial speculators who lost money in Bear Stearns.
We bring this up because some Democrats in Congress now are arguing that since the Fed has led an unprecedented bailout of a Wall Street investment bank, the Congress is morally obligated to rescue the little people who have lost or will lose their homes because they entered into ill-advised subprime mortgages.
But people with high debt-to-income ratios who took out mortgages that did not require any down payment, had adjustable interest rates and were based on inflated appraisals, should have known they were signing their own financial death warrants.
The Fed also bears responsibility for blowing hot air into the housing bubble by keeping money too cheap for too long.
As the Fed and Congress try to unwind the subprime mortgage fiasco, there is going to be a role for the federal government, perhaps by issuing bonds to refinance mortgages after they have been written down. We just hope that in the process, the rescuers don't lose sight of Rule No. 1.