New York Federal Reserve Bank Chairman Timothy Geithner defended the bank's decision to assist in the JPMorgan Chase merger with Bear Stearns, saying it was the best option available under the circumstances.
Geithner made the comments before lawmakers on Thursday as officials involved with the deal gave their testimonies to the congressional Joint Economic Committee in Washington.
It is important to recognize that had we not acted we would in effect have penalized those individuals, companies and financial institutions that had behaved more prudently, but would have suffered significant damage from the effects of default by a major institution, he said.
On March 13, the Federal Reserve and other regulatory agencies were contacted by Bear Stearns, which explained the precarious situation the company faced. Investors were rushing to pull out of investments amid market rumors that the company could not pay its obligations.
What we were observing in U.S. and global financial markets was similar to the classic pattern in financial crises, he said. He mentioned a self-reinforcing downward spiral of asset sales, lower prices, higher volatility and still lower prices.
Geithner was a lead negotiator during talks between the New York Fed and JPMorgan.
He noted that Bear Stearns owners or employees were not spared from losses related to the emergency action. While taking action could add to the risk of moral hazard, he said the lesson learned from the experience would lead equity holders to diminish incentives for undue risk taking.
Due to regulatory restrictions, the Fed loaned the $30 billion loan to Bear Stearns through JPMorgan Chase. A few days later JPMorgan Chase bought the investment bank at a fire sale price of $2 per share or $236 million. A few days later that was raised to $10 per share after an outcry by shareholders and employees.
Without the $30 billion loan to back up risky assets owned by Bear Stearns, JPMorgan would not have gone through with the deal. The deal requires that JPMorgan bear the risk for up to $1 billion in losses. The New York Fed would be responsible for the remaining $29 billion.