Posted on 04/01/2008 3:58:06 AM PDT by jazusamo
There was a real irony in the recent intervention by the Federal Reserve System to provide the money that enabled the firm of JPMorgan Chase to buy Bear Stearns before it went bankrupt. The point was to try to prevent a domino effect of panic in the financial markets that could lead to a downturn in the economy.
The irony is that it was almost exactly a hundred years ago -- 1907, to be exact -- that the original J.P. Morgan arranged a bailout of a troubled financial institution for the same purpose of preventing a panic that could end up with the whole economy declining.
The difference is that J.P. Morgan and his fellow bankers used their own money, while the Federal Reserve System used their power to create money.
What that means is that the value of your money and my money -- all Federal Reserve Notes -- goes down when more Federal Reserve Notes are issued to subsidize the purchase of Bear Stearns by JPMorgan Chase.
It wasn't really a bailout because the stockholders of Bear Stearns lost their shirts. But the firm of JPMorgan Chase got money from the government to seal the deal.
In other words, we all paid to keep Bear Stearns out of bankruptcy, whether we all realize it or not. Whether that was better than the alternative is a separate question -- and one whose answer may never be known.
But the big difference between this year's rescue to stabilize the financial markets and that 101 years ago is that this year's government rescue leads to demands that still more rescues -- including real bailouts -- should be extended to homeowners and others.
Back in 1907, nobody could demand that the original J.P. Morgan bail out more people with his own money. But whatever the government does sets a precedent and causes more special interests to demand that they get the same treatment.
There is another irony in this situation. There was no Federal Reserve System in 1907. That is why Wall Street bankers like J.P. Morgan had to do their own heavy lifting with their own money.
Somehow that did not sit right with the Progressives of that era who, like today's liberals, seemed to think that things should not be left to the market when the government can step in and make everything right.
Such thinking led in 1914 to the creation of the Federal Reserve System.
Unlike other countries, the United States had gotten along for generations without a central government bank. But President Woodrow Wilson thought that the monetary system of the country was too important to let private bankers play such a large role as J.P. Morgan had played in 1907.
Describing the Federal Reserve System created during his administration, Woodrow Wilson said: "It provides a currency which expands as it is needed and contracts when it is not needed."
The power to expand and contract the currency was "put into the hands of a public board of disinterested officers of the Government itself."
Their task was to prevent financial panics, bank failures and a catastrophic contraction of demand. It sounded wonderful -- and such sounds count for a lot in politics.
In reality, however, the biggest financial panic in American history occurred under the Federal Reserve System in 1929, followed by thousands of bank failures and an unprecedented contraction of the money supply by one-third during the Great Depression of the 1930s.
There is no question that the people who run the Federal Reserve System today are a lot more knowledgeable about economics than those who ran it back in the days of the Great Depression. Indeed, the average student who has passed Economics 1 today is probably more knowledgeable than those who ran the Federal Reserve System back during the Great Depression.
Being a disinterested government official does not mean that you know what you are doing. That fact gets left out of the equation in a lot of proposals for new government programs.
Thomas Sowell is a senior fellow at the Hoover Institute and author of Basic Economics: A Citizen's Guide to the Economy.
Ping.
I was just reading about that fact that JP Morgan tried to save the stock market in the past in my daughter’s U.S. History book. It was so eerie that I read the section out loud for her and my husband one day last week. It was spooky. Sounds awfully close to what is happening today. The book is used by homeschoolers. It was Abeka’s 11th grade US History. I was checking to see how they handled the Great Depression. It was great!
I actually get depressed when I realize he won't live forever.
That’s interesting, my daughter homeschools her three but the oldest is 10th grade or I’d check it out, I’ll ask about it anyway. :)
Does she have to use the same schoolbooks?
There are bookstores that sell books for homeschooling. I don’t know a lot about it but I do know they are not textbooks the public schools use.
By our own FR author Larry Schweikart
Recommended by Listenhillary as a much broader look at history of the USA than most grade school textbooks.
A Patriot’s History of the United States: From Columbus’s Great Discovery to the War on Terror
http://www.amazon.com/Patriots-History-United-States-Columbuss/dp/1595230327/ref=ed_oe_p
Thanks for that, lh, will forward the info.
That is nothing like what's happening now, as Mr. Sowell says.
Sowell is wrong on this one. The Fed did not print money for the deal. A corporation was set up to hold the $30 billion in the marked down securities. The Fed gets all the upside, and all of the downside except for the first billion in downside which JPM would absorb. The Fed will most likely end up making money on the deal.
Sowell mentions this in some more detail in "Basic Economics". The Depression was something I hadn't really understood in an economic sense until I read that tome.
For that Dr. Sowell...thank you.
Fast forward to 1893, when Morgan has to bail out the government. By then, PRIVATE banks were no longer permitted to print money, only NATIONAL banks---and they could not print money fast enough to be "elastic" when demand rose, or contract when demand fell. So while Morgan was the great hero, the larger story was that instead of going BACK to private note issue, the government centralized the money supply even more.
See my post, below.
Mr. Sowell was referring to 1907, I was referring to 1929.
And yes, the similarities to 1929 and what is happening today are VERY spooky. JP Morgan tried to do the same thing in 1929, and it worked for a little while, less than a month. Then the crash of 1929 happened. JP Morgan did this more than once. I guess he thought he could repeat it again. Very generous of him, frankly.
Thanks, LS.
You are referring to his son, "Jack" Morgan, who with yet another syndicate tried to save the U.S. economy in 1929 Insull, Morgan, Vanderlip, and dozens of other financiers tried to stem the tide with private investments, but they couldn't. J.P. Morgan was right: it was simply too big anymore.
Thank you for your correction. It is appreciated.
I love history, but keeping all of those important details clear, can slip sometimes.
It’s sort of like trying to keep the Adams family straight; or the Tudors.
LOL!!
I am not so sure it's that simple. And if it were, it simply blows any traditional understanding of "moral hazard" out the window. The Fed intervention is extraordinary (and therefore questionable) to begin with; but to in turn profit from a forced bludgeoning of Bear, and then to open the lending window to other Wall Street firms, is, let's see...are there words for this? A pistol-whipping? It makes "moral hazard" look like Sunday School. It comes off looking as if The Fed held Bear down while JPM picked their pockets.
Finally, if the Fed is long these positions at firesale prices, it has no business seeking added regulatory muscle; that would only be warranted if taxpayer money were put at risk with no upside. Yet the Bear deal is being used as rational for increased regulatory oversight, so that doesn't wash.
The Fed isn't in the business of participating for profit. At least, not in a moral universe. If the Fed has the upside on the positions, what does JPM gain, besides Bear? Pity using the word "moral" three times in a post is belaboring it.
If the fed does indeed have the upside, and JPM was given the head of Bear on a platter, then I think I'm going to be sick, and people a lot smarter than I am are going shred this deal in the courts.
I have a higher expectation of the integrity of Paulson and Bernanke, which causes me to give them the benefit of the doubt. Therefore I don't think your synopsis (which I have seen bandied about as conjecture in print) is the full story.
I think you understand. Bear's only other alternative was liquidation or bankruptcy, which in normal circumstances wouldn't be so bad as far as the rest of the world is concerned, but with the state of the credit markets the way they are, nobody except the Armageddon types wanted such a thing. OTOH, the Fed wanted to avoid moral hazard, so that's why it set the $2 share price. It must have had some remorse, because it changed the price to $10. But that doesn't make much sense either. If someone bought Bear at $150, the difference between $2 and $10 is nothing. It's still a huge loss. The $10 price only made a difference to very long term holders who bought at a much lower price, or to those who bought Bear once the share price collapsed.
JPM does get a sweet deal, but it was in the right place at the right time, and stepped in quickly to back all of Bear's pending and future deals.
Finally, if the Fed is long these positions at firesale prices, it has no business seeking added regulatory muscle; that would only be warranted if taxpayer money were put at risk with no upside. Yet the Bear deal is being used as rational for increased regulatory oversight, so that doesn't wash.
I don't think the Fed is seeking more regulatory muscle. I think that's pretty much the idea of the Franklin Delano Bush administration. And it's being based on the larger credit market problems, not just Bear.
The Fed isn't in the business of participating for profit. At least, not in a moral universe. If the Fed has the upside on the positions, what does JPM gain, besides Bear? Pity using the word "moral" three times in a post is belaboring it.
JPM wanted to avoid those $30 billion in assets, and take the rest of Bear. So if the Fed makes a profit, it's doing so on assets nobody else wanted or wanted to make a loan against. And the Fed is in the business of making a profit. It doesn't receive appropriations from Congress, and pays its excess profits to the Treasury after paying its operating expenses.
If the fed does indeed have the upside, and JPM was given the head of Bear on a platter, then I think I'm going to be sick, and people a lot smarter than I am are going shred this deal in the courts.
How quickly people forget the dire situation of the financial world a couple of weeks ago. Bear was toxic. The deal it got was the only deal it was going to get. The only people who may see the courts will be the ones who caused a "run on the bank" at Bear, if investigations find out that was intentionally set in motion by short sellers.
bttt
“But whatever the government does sets a precedent and causes more special interests to demand that they get the same treatment.”
Only 2 million people have defaulted on their mortgages, in a population of over 600 million. Now that they’re being bailed out (and the banks), you know the line will form again for the next man-made “crisis” right after those dopes are “served.” *Rolleyes*
Such a depressing thought! We are SO screwed over by Government, it isn’t funny anymore. It never was to begin with, but we’ve been in this pot of gradually warming water for so long, we won’t even know when we hit the boiling point.
Grrrrrrr!
Actually we're at about 304 million right now.
Great. More room for me! :)
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