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Fed Makes JPMorgan Conduit for Bear Stearns Loan

Mar 14, 2008

Bear Stearns headquarters, New York City. (Mario Tama/Getty Images)
Bear Stearns headquarters, New York City. (Mario Tama/Getty Images)

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WASHINGTON—The Federal Reserve, in an emergency move believed not to have been used since the Great Depression, threw a lifeline to Bear Stearns on Friday by making JPMorgan Chase a conduit for funds to the investment bank.

At a hastily called meeting, the U.S. central bank's Board of Governors unanimously authorized JPMorgan Chase to borrow from the Fed on behalf of Bear Stearns, which cannot borrow directly from its "discount window"—a privilege reserved for banks that accept deposits.

Commenting on the arrangement, the Fed said in a statement it was ready "to provide liquidity as necessary to promote the orderly functioning of the financial system"—its third surprise announcement within the past eight days aimed at shoring up shaky credit markets.

Mechanics of the Fed's
Bear Stearns Rescue Plan

NEW YORK—Following are details on how the Federal Reserve Bank of New York's planned rescue of Bear Stearns Cos. Inc. is intended to work. JPMorgan Chase & Co has agreed to provide secured funding to Bear, as necessary, for up to 28 days, through borrowings from the Fed's discount window.

The Discount Window:

The discount window is where banks in need of short term funds can borrow directly from the Fed. But Bear Stearns is a non-depository institution and ineligible to borrow directly at the Fed's discount window, Fed staff said.

Since Bear Stearns is not entitled to go to the discount window, JPMorgan, a bank, "is acting as a conduit, to go to the discount window and lend to Bear Stearns," said Kenneth Kim, economist with Stone & McCarthy Research Associates, in Princeton, New Jersey.

The interest rate on Fed discount window loans is known as the discount rate and is currently 3.5 percent. The rate is set by the Federal Reserve Board, normally in conjunction with the benchmark federal funds target rate, which is now 3.0 percent.

Both of these rates will be reviewed by the Fed at its March 18 policy meeting.

Collateral From Bear Stearns:

JPMorgan will post collateral from Bear Stearns at the discount window and the Fed is looking to Bear Stearns collateral to repay the loan, and not to JPMorgan, Fed staff said.

Collateral The Fed Accepts:

At the discount window, these are some of the types of collateral the Fed can accept in exchange for making short term loans, according to the New York Fed Web site:

U.S. Treasury securities

Agency debt

Corporate bonds

Mortgage-backed securities (includes agency and so-called "private label" or non-agency MBS).

Purpose Of The Discount Window:

"The Discount Window functions as a safety valve in relieving pressures in reserve markets; extensions of credit can help alleviate liquidity strains in a depository institution and in the banking system as a whole. It also helps ensure the basic stability of the payment system by supplying liquidity during times of systemic stress," according to the New York Fed Web site.

The Fed's Total Portfolio:

The Federal Reserve's total portfolio of securities held outright in the SOMA (System Open Market Account) was $703.4 billion as of Wednesday, according to New York Fed data.

Recent Activity At The Discount Window

Traditionally, banks have been wary of borrowing at the discount window because that carries an implicit stigma that an institution could be in trouble. But since the Federal Reserve cut the discount rate in August in response to the first wave of credit market upheaval, discount window borrowing has increased somewhat, with occasional spikes.

For the week ended Sept. 12, 2007, primary credit borrowings nearly tripled from the prior week to a daily average of $3.16 billion, hitting a single-day peak of $7.15 billion on Sept. 12 -- their highest since banks borrowed $45.5 billion on the day after the Sept. 11, 2001 attacks on New York and Washington.

Term Auction Facility

Discount window borrowing also was heavy in mid-December and early January amid high year-end cash demands. But by then, the Fed had also launched its new Term Auction Facility (TAF) to pump more funds into the banking system. This facility allowed banks to borrow from the Fed anonymously and avoid the "lender of last resort" stigma associated with having to turn to the discount window after failing to secure funds in the interbank market.

The Term Auction Facility has since been expanded twice, and the two March auctions will total $100 billion, compared to $60 billion in February.

The Fed announced a new short term lending facility this week to lend up to $200 billion in Treasuries over a 28-day period starting March 27, the TSLF (Term Securities Lending Facility), which is exclusively for use by primary dealers.

Historical Precedent

According to the Federal Reserve Bank of Richmond's Web site, the Fed Board could determine that if "unusual and exigent circumstances" exist, discount window loans may be made to individuals, partnerships, and corporations that are not depository institutions.

"Such lending can take place only if the Board and the local Reserve Bank find that credit from other sources is not available and that failure to lend may have adverse effects on the economy. This last authority has not been used since the 1930s," the Richmond Fed said.

Fed senior staff said on Friday that the Fed authorized lending to non-bank firms again in the 1960s but does not believe any such institutions took them up on the offer.

Next Week's Discount Window Data:

Market analysts will watch next week's discount window data for the week through Wednesday March 19 very closely, because that may indicate what Bear's initial need for funding is. The data are scheduled for release at 4:30 p.m. on Thursday March 20.

In the most recent week ended March 12, the Fed said discount window primary credit borrowings totaled $99 million, including $23 million on Wednesday.

The ultimate size of the Fed's effort on behalf of Bear Stearns is uncertain and depends on the ability of the investment bank to provide collateral for credit, Fed staff said.

The process was initiated after Bear Stearns called the Fed, the staff said. That triggered the emergency meeting of the Fed Board on Friday morning.

The Fed staff members declined to say why JPMorgan was selected as the intermediary.

Under the arrangement, JPMorgan will post collateral from Bear Stearns at the discount window. The Fed is looking to Bear Stearns for collateral to repay the loan, not to JPMorgan, staff said.

Bear Stearns' need for credit and whether it has collateral to post will determine the potential outer limits of the central bank's lending, they said, adding that the credit extensions have to be collateralized to the satisfaction of the Fed.

Fed staff told Reuters they believed it was the first time such an arrangement had been resorted to since the era of the Great Depression.

They said that while the precedent of extending central bank credit to non-depository institutions dates to the 1930s, the central bank had authorized lending to non-depository institutions in the 1960s. However, staff said they did not believe companies took advantage of that arrangement.

To approve the plan, the Fed drew on emergency procedures that allowed the Board to give its OK on a 4-0 vote. Under normal procedures, a minimum of five votes would have been required.

The normally seven-member Board currency has two vacancies and one member, Frederic Mishkin, was unable to participate in the meeting.

U.S. Democratic Presidential Candidates on Economy


The following are some recent comments on economic policy from the U.S. Democratic presidential candidates.

New York Sen. Hillary Clinton

Clinton unveiled a plan she said would save $55 billion by taking on corporate interests such as drug companies, oil firms and Wall Street. The plan included a proposal to overhaul credit-card regulations to shield consumers from high fees and sudden rate hikes.

Clinton has proposed a retirement savings plan for lower- and middle-class families that would include tax credits as incentives for savings.

Her health-care plan would require all Americans to get health insurance. Under a public-private partnership, they would keep existing coverage or choose from private insurance options available to members of Congress. Individuals could also choose a public plan similar to Medicare.

On China, Clinton has said tougher import standards are necessary to keep consumers safe. "We also have to deal with their currency manipulation," she said.

Illinois Sen. Barack Obama

Obama offered a plan he said would create 5 million new jobs in the green energy sector and establish an infrastructure bank to spend $60 billion over a decade to repair deteriorating roads, bridges and waterways. He said he would pay for the plan by ending the Iraq war and raising taxes on corporations and wealthy Americans.

Obama has called for a refundable tax credit worth $4,000 for college tuition every year, and wants to automatically enroll workers in retirement plans to boost savings.

He has proposed a national public insurance program to allow individuals and small businesses to buy affordable health care similar to that available to federal employees.

He said if trade partners are manipulating their currency, "we take them to the mat on this issue. It means that we are also not running up deficits and asking China to bail us out and finance it, because it's pretty hard to have a tough negotiation when the Chinese are our bankers."