Can the Fed Bail Out a Non-Bank?

The point about the Fed's power to backstop a deal from a bank to a non-bank is an interesting one we had not thought about, although we did point out Bear's non-bank status in our 'smoking gun' piece when we noted it does not appear on any of the OCC lists of banks with large derivative exposure.

The secondary point about four governors approving without including the fifth governeror Mishkin is only interesting if he were to object.

This will be a first in a series of tests of the boundaries of the Fed's power to intervene in US markets. This is not analagous to the LTCM situation where the Fed merely arranged the deal. In this case the Fed holds all the counterparty risk for JPM, and is really the principal with JPM acting as its agent.

The real test, the real 'crossing of the Rubicon' will be when the Fed exhausts its own asset side of its balance sheet, expressed as the Fed Held portion of the H.41 report. A few more deals like this and they will be there. What they do next, what new linkup they provide, will be where we cross the Rubicon from the existing Federal Reserve system to the netherworld of a purely whimsical form of money beyond even the discipline of the public debt markets.

Housing Group Challenges Fed's Bear Stearns Deal
By REUTERS

Published: March 16, 2008 Filed at 1:07 p.m. ET

WASHINGTON (Reuters) - A housing and fair lending activist group has challenged the legality of the Federal Reserve's quick approval of financing for Bear Stearns via JPMorgan Chase , questioning the Fed's authority to approve the deal because it involves a non-bank institution.

Inner City Press Community on the Move, in a complaint filed with the Fed late Saturday, called the central bank's brokering of the deal "entirely illegal" and anticompetitive, and questioned whether sufficient Fed members had voted for it.

In a first step toward challenging the bailout, Inner City Press questioned the legality of the Fed approving the deal without public notice, on the grounds Bear Stearns "is not a banking holding company and does not own a bank."

The Fed approved financing to Bear Stearns through JPMorgan in an emergency meeting Friday morning.

It was the Fed's first rescue of a broker since the Great Depression and its latest effort to soothe financial markets roiled by fallout from rising mortgage defaults.

But Matthew Lee, executive director of Inner City Press, vowed to take all needed legal actions against the deal.

"The Fed has hit a new low with this, they did nothing to protect consumers from predatory lending and now their response is to bail out one of the most notorious enablers of predatory lending with no benefit to struggling consumers," said Lee.

"This should be taken as far as it can go to finally bring the Federal Reserve to account that they work for the public interest and not only Wall Street, particularly in a time of crisis," he told Reuters on Sunday.

The Fed could not immediately be reached for comment.

Inner City Press, a nonprofit group that has challenged the nation's key bank mergers over the past decade in an effort to ensure poorer communities are served fairly, also questioned why only four of the five Fed governors approved the measure.

The Fed approved the deal between JPMorgan and Bear Stearns under Depression-era laws allowing it to do so under "unusual and exigent circumstances." This provision, however, requires an affirmative vote of not less than 5 members of the board.

At present, there are only five members on the board with two vacancies, but only four approved the measure because governor Frederic Mishkin was not present, according to the Federal Reserve.

But current law mandates that no less than five members can vote on the matter and states that members can be contacted through any electronic means, including by telephone and e-mail.

"There has been no showing that, given technology in 2008 (as opposed to the 1930s when this language was enacted), the required attempts to contact Gov. Mishkin were made," Lee wrote in the complaint.

Inner City Press also questioned whether the deal could be finalized without antitrust review.

"Third, to allow this relation between the nation's third largest bank and fifth largest brokerage, without any antitrust review, even with the required votes (which the Fed) did not have, is unlawful," the complaint stated, requesting public hearings on the matter.

The complaint also asks for a probe into Bear Stearns' disclosure of its financial condition, citing an interview the firm's chief executive gave on CNBC television earlier in the week during which no mention of the scope of the firm's financial troubles were made.

(Reporting By Joanne Morrison; Editing by Tim Dobbyn)