Geithner's unsung role in the Bear Stearns collapse

Tom Geithner, our flailing Treasury Secretary, has been cited as having helped cause the collapse of Lehman Brothers. This failure helped to precipitate the financial turmoil which has rippled from Wall Street to Main Street. What has been ignored, though, is that he also played a role in the collapse of Bear Stearns. The recent book, "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street" by William Cohan  tells the tale of the collapse of Bear.

Bear Stearns faced a liquidity crisis because of its funding needs. Wall Street firms and banks were not only too panicky to loan to Bear but also had a grudge against Bear for its hardball tactics and its failure years before to join them in rescuing Long Term Capital Management, a giant hedge fund that was in the process of self-destructing. Also, these firms had a desire to pick up the business that would be available if Bear collapsed.

What did Geithner do-or did not do, in this case?

He refused to open up the Federal Reserve  Discount Window to help meet the short-term liquidity needs of Bear Stearns. This is a lending facility that had previously been unavailable to investment banks. One might think that the prohibition prevented the window from being open to Bear. However, one would be wrong.

Geithner did open the window only a few days after Bear basically went out of business in a federally-facilitated fire sale to J.P. Morgan.

Now, the moral of the story is not just that Geithner could have acted to prevent the collapse of Bear Stearns. There were problems with the firm and its structure; a loan may have just postponed the inevitable. However, a loan may have just been able to help stabilize the markets-especially the mortgage and stock markets. The fact that he did so only  a few days after Bear Stearns was thrown into the arms of J. P. Morgan may also indicate a certain dithering habit on the part of Geithner that seems to have carried over into the Treasury Department.

Geithner also defended the Fed's decision not to open the discount window until Sunday night, after Bear could have benefited from it. "The way the Federal Reserve Act is designed, and the way we think about the discount window for banks, is we only allow sound institutions to borrow against collateral in that context," he said. "I can only speak personally for this, but I would have been very uncomfortable lending to Bear, given what we knew at that time." He said that both the opening of the Fed window and the earlier creation of the facility "were exceptionally consequential acts, taken with extreme reluctance and care, because of the substantial consequences it would have for moral hazard in the financial system going forward. And I do not believe it would have been appropriate for us to take that act Sunday night if we had not been faced with the dynamics that were precipitated by, accelerated by, the looming prospect of a Bear default."

In a separate interview a few months later, Geithner again defended his decision not to open the discount window to Bear Stearns. He said he would not have taken that extraordinary step three months earlier, as Schwartz, Dodd, and others had been hoping. "People had been pushing us to do it for a long time," he said. "We consciously chose not to do it, and I think rightly so, because it is a consequential act. You don't want to do it unless you think there's no other option available to mitigate the risks of the system."