Bear Stearns Rescue Defended

Bernanke and Treasury Department Undersecretary Robert Steel said that the consequences to the U.S. economy and financial system would have been far more serious had the government allowed the nation's fifth largest investment house to go bankrupt.

"Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain," Bernanke told the Senate Banking Committee.

The panel conducted a five-hour hearing as lawmakers sought to understand the decisions made during the hectic weekend of March 14-15 after Bear Stearns informed the Fed that it was on the verge of having to file for bankruptcy protection because nervous creditors were demanding to be repaid.

The investment house was purchased by JP Morgan Chase & Co. with assistance from the Fed in the form of a loan backed by $30 billion of Bear Stearns assets. JP Morgan has agreed to absorb the first $1 billion of losses if the value of the assets declines, but taxpayers are at risk for the remaining $29 billion.

Bear Stearns, with a stock price around $150 per share a year ago, was sold for $10 a share, becoming the biggest victim of a severe credit crisis that hit financial markets in August.

That crisis, which was triggered by a prolonged housing slump and cascading mortgage defaults, has made it harder for consumers and businesses to get loans and helped to push the country to the brink of a recession.

Democrats on the Senate Banking Committee questioned why the Fed was willing to put such a large amount of money at risk to protect Wall Street while as many as 3 million homeowners are facing the risk of defaulting on their mortgages with the administration balking at greater efforts to help them.

"Was this a justified rescue to prevent a systemic collapse of financial markets or a $30 billion taxpayer bailout for a Wall Street firm while people on Main Street struggle to pay their mortgages?" Senate Banking Committee Chairman Christopher Dodd asked Bernanke and the other witnesses.

Bernanke said that government's effort was not a bailout for Bear Stearns shareholders, who will suffer big losses, but an effort to protect the financial system and ultimately the entire economy, which could have faced severe consequences from a Bear Stearns bankruptcy.