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Fed Didn't Consider Bear Stearns Bailout Days Before Its Bailout

Tickers in this article: JPM

NEW YORK (TheStreet) --  Transcripts released by the Federal Reserve on Friday indicated that the central bank's Federal Open Market Committee didn't discuss a direct bailout of Bear Stearns just days before it provided the struggling investment bank with a $12.9 billion loan that forestalled its bankruptcy and allowed JPMorgan to acquire it. Transcripts also revealed that Bear's struggles caused members at the March 10, 2008, meeting to consider the impact were the central bank to decide to cut its lending to any individual primary dealer.

The Fed effectively bailed out Bear Stearns through its March 13 loan, and a March 17 facility called Maiden Lane that allowed the central bank to purchase $30 billion in assets from the investment bank. Those two liquidity measures allowed for JPMorgan to buy Bear Steans and forestall the investment bank's bankruptcy.

Those same efforts weren't taken just months later when Lehman Brothers , another investment bank, fell into a liquidity crisis in the summer and fall of 2008. On Sept. 15, 2008, Lehman brothers filed for bankruptcy after the Federal Reserve refused to lend to the investment bank as it worked to sell assets, or find an equity investor to forestall its demise.

At an unscheduled March 10 FOMC meeting , Fed officials discussed the implications of their direct lending to primary dealers, many of them standalone investment banks mostly outside of their regulatory purview. Using Bear Stearns struggles as an example, officials also began to contemplate the impact of cutting off lending to any back. Fed officials, however, didn't discuss any of their eventual efforts to lend directly to Bear Stearns as part of its rescue by JPMorgan.

On March 10, the Fed announced an expansion of its securities lending program, which allowed the central bank to lend up to $200 billion in Treasury securities to primary dealers for 28 days, rather than overnight, in exchange for agency residential mortgage-backed securities (RMBS) and non-agency RMBS.

At the time, market participants questioned whether the Fed's expanded lending facility, called the Term Securities Lending Facility, or TSLF, was a direct response to liquidity pressures at Bear Stearns. Transcripts revealed that Bear's liquidity crisis and similar struggles among major financial intermediaries did drive the Fed's decision to create TSLF.

Bill Dudley, manager of the System Open Market Account and a former New York Fed president, led off the March 10 meeting by describing the risks emerging in markets in the spring of 2008. Dudley referenced the failure of Peloton, a major hedge fund, and the problems of Thornburg Mortgage and Carlyle Capital, two vehicles that would later fail after struggling to meet margin calls.

Dudley raised those examples to point out that a vicious circle of liquidity issues, morphing into solvency issues, could cause major financial intermediaries to fail.