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NewsFlash: March 17, 2008

Fed action leaves underlying instabilities unaddressed

Responding to the Federal Reserve’s emergency action on the sale of Bear Stearns, John Irons, Research and Policy Director of the Economic Policy Institute, issued this statement: 

“Emergency actions by the Federal Reserve over the weekend to back and coordinate the fire-sale of the investment bank Bear Stearns were necessary to ensure the stability of the financial market, but underlying instabilities remain unaddressed.
 
“Without this action, spillovers to other financial institutions would threaten credit markets more broadly and worsen the already worrisome credit crunch. For typical American families, this would have made it much harder to obtain loans for homes, automobiles, and education.

“A broader bailout of institutions exposed to risky housing debt looks more and more likely.  Under one scenario, the federal government would purchase mortgage-backed securities, thus removing a good deal of risk from the balance sheet of current holders while increasing market liquidity. Under these circumstances, taxpayers will likely be asked to foot at least part of the bill. 

“If and when taxpayer money is used, the government should insist on full transparency, broad structural reforms, and perhaps an equity stake in companies that benefit from the bailout.  And taxpayer money should not be used to fully offset the costs of excessive risk-taking by companies and their directors; these companies and individuals must bear some of the costs too.

“Recent developments underscore that the Federal Reserve is in danger of losing credibility. Rather than calming the markets, Fed action is coming to be seen as a sign that more trouble is on the way — the loss of value of Bear Stearns even after the Fed took action last Friday is the latest sign that the Fed might be compounding market fears.  To ensure future credibility, the Fed must also be fully transparent in their transactions.”
 

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