Several people emailed me questioning the Fed’s move to bail out Bear Stearns. I spoke of the relationship in Beleaguered Bear Stearns Bailed Out and What Brought Down Bear Stearns?

Close examination of the situation shows the Fed provided unsecured funds to JP Morgan (not Bear Stearns directly) for JP Morgan to bail out Bear Stearns, rather than the Fed bailing out Bear Stearns directly.

Here is the text of the statement from JPMorgan.

Today, JPMorgan Chase & Co. [JPM] announced that, in conjunction with the Federal Reserve Bank of New York, it has agreed to provide secured funding to Bear Stearns, as necessary, for an initial period of up to 28 days. Through its Discount Window, the Fed will provide non-recourse, back-to-back financing to JPMorgan Chase. Accordingly, JPMorgan Chase does not believe this transaction exposes its shareholders to any material risk. JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company.

Bloomberg picked this idea up in Fed Invokes Little-Used Authority to Aid Bear Stearns.

Federal Reserve Chairman Ben S. Bernanke invoked a law last used four decades ago to keep Bear Stearns Cos. from collapsing after the securities firm sought emergency funding from the central bank.

The loan to Bear Stearns required a vote today by the Fed’s Board of Governors because the company isn’t a bank, Fed staff officials said. The central bank is taking on the credit risk from Bear Stearns collateral, lending the funds through JPMorgan Chase & Co. because it’s operationally simpler to accomplish than a direct loan, the staff said on condition of anonymity.

Bernanke took advantage of little-used parts of Fed law, added in the 1930s and last utilized in the 1960s, that allow it to lend to corporations and private partnerships with a special board vote. The Fed chief probably sought to stave off a deeper blow to the financial system from a Bear Stearns collapse, former Fed researcher Keith Hembre said.

“The Fed really doesn’t have any obligation to help a non- bank aside from its role or responsibility to keep the financial markets functioning,” said Hembre, who helps oversee $107 billion as chief economist at FAF Advisors Inc. in Minneapolis. “They made a judgment, probably an accurate one, that they’re not going to function very well if you’ve got a full-blown crisis with a major Wall Street firm.”

Such votes require approval from five Fed governors. The seven-member Fed board currently has two vacancies, and one governor, Randall Kroszner, is serving past the Jan. 31 expiration of his term.

Shotgun Wedding

Bloomberg is reporting Bear Stearns May Lose Independence After Fed-JPMorgan Bailout.

Bear Stearns Cos.’s 85 years as an independent Wall Street firm may be coming to an end as JPMorgan Chase & Co. considers buying the crippled company.

Teetering on the brink of collapse from a lack of cash, Bear Stearns got emergency funding yesterday from the Federal Reserve and JPMorgan in the largest government bailout of a U.S. securities firm.

JPMorgan, led by Chief Executive Officer Jamie Dimon, is considering buying Bear Stearns, according to three people briefed on the matter. No agreement has been reached and it’s possible no deal will be completed, said the people, who declined be identified because the discussions are confidential. A person close to JPMorgan said the bank may also be interested in buying Bear Stearns’s prime brokerage unit, which provides loans and processes trades for hedge funds.

The Fed acted to prevent the failure of the second-biggest underwriter of U.S. mortgage bonds and forestall a potential market panic as losses by banks and brokers reached $195 billion and stocks plunged for a third day this week.

“I don’t think they can afford to let Bear go,” said Charles Geisst, the author of “100 Years on Wall Street,” referring to the New York Fed bailout. “At this particular moment in time, it would be a devastating blow to the markets.”

Lehman Brothers Holdings Inc., Citigroup Inc. and Bank of America Corp. also led declines as all 10 industry groups in the Standard & Poor’s 500 Index fell yesterday. Lehman, the biggest underwriter of U.S. mortgage bonds, said it obtained a $2 billion, three-year credit line from 40 banks.

“The future for Bear will be found in a forced marriage,” said Charles Peabody, an analyst at Portales Partners LLC in New York who rates the stock a ell. Their business model is broken. They don’t have the ability to go it alone.”

The Fed, under Chairman Ben S. Bernanke, voted unanimously to lend the funds through JPMorgan because it would be operationally simpler than a direct loan to Bear Stearns, the staff said on condition of anonymity. The regulator invoked a little-used law that allows it to make loans to corporations and private partnerships, which required a Board vote, according to the staffers.

Arranged Marriages

The Bear Stearns (BSC) / JP Morgan (JPM) announcement follows closely on the heels of the announced wedding between Bank of America (BAC) and Countrywide Financial (CFC).

The wedding season will be in full bloom by June. Expect to see more shotgun wedding announcements between now and then.

Mike “Mish” Shedlock
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