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Capitol Hill Grill

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Bernanke to answer questions about Fed's role in Bear Stearns deal.

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Federal Reserve Chairman Ben Bernanke will face stiff questions regarding the Fed's role in JPMorgan's (JPM) purchase of Bear Stearns (BSC).

Threatened by a liquidity crunch and potential insolvency, two weeks ago Bear Stearns agreed to be purchased by JPMorgan for just $2 per share. The price was later upped to $10 and the Fed provided $29 billion to backstop Bear's illiquid mortgage-backed securities portfolio. In a letter released yesterday by The Wall Street Journal, Treasury Secretary Hank Paulson confirmed the Treasury Department would actually foot the bill should the Fed lose money on the deal.

According to Bloomberg, tomorrow's hearing will focus on precedent. Senator Charles Grassley said the Bear Stearns example "...sends a very dangerous signal. People are willing to take chances if they think that the federal government is going to step in and bail them out all the time."

While politicians praise the central bank for helping avert a systemic collapse, they fret about Bernanke's rewriting of the rules as they concern government's role in the financial markets. Together with Paulson's new regulatory proposal, control is being increasingly consolidated.

Many support the move, hoping the simplification of oversight will prevent crises like the one we're currently experiencing. Although flawed, the existing system keeps power in the hands of many, rather than few.

The problem isn't that the system is poorly organized; it's that those in charge don't take the necessary actions, even when they recognize a problem. Back in 2005, at the peak of the housing bubble, the Fed expressed concern over poor underwriting standards and risky mortgages. It issued weak guidance on lending practices that had little or no effect. In short, regulators closed their eyes as Wall Street lenders like Bear, Lehman Brothers (LEH) and UBS (UBS) pushed the envelope with new and creative mortgage products. In the rush to beat the bursting of the bubble, underwriting standards were thrown out the window.

We are now reaping the consequences of their inaction.

For more on Federal Reserve Chairman Ben Bernanke, check out Hoofy & Boo's always astute report.

No positions in stocks mentioned.

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