30 April 2008

Independent: Bear Stearns bail-out 'worst policy mistake'

A former leading Federal Reserve official has branded the US central bank's $29bn bail-out of Bear Stearns as "the worst policy mistake in a generation". Vincent Reinhart, who was director of monetary affairs at the Fed until the middle of last year, believes the Fed has set a dangerous precedent for itself, ending its role as "honest broker" once and for all.

The remarks are some of the harshest criticisms to date of the Fed's tactics surrounding the collapse of Bear Stearns.

Speaking at a discussion looking at what lies beyond the credit crunch, Mr Reinhart compared the bailing out of Bear, which allowed JP Morgan Chase to save the bank, to the great contraction of the 1930s and the great inflation of the 1970s.

The financial crisis in full

He said the situation "eliminated forever the possibility the Fed could serve as an honest broker" in future situations, citing the case of when the Fed encouraged creditors to rally round and bail out collapsed hedge fund Long-Term Capital Management, but did not stump up its own money.

Mr Reinhart, whose role at the Fed also saw him act as secretary and economist to the Federal Open Market Committee, said that in such situations, banks will ask how much the Fed is willing to "contribute to the solution".

He questioned whether other options might have been more appealing, such as taking a tougher line with JP Morgan, which was on the verge of walking away from the deal to buy Bear Stearns before the Fed provided its $29bn funding lifeline.

The Fed, led by chairman Ben Bernanke, has consistently said that it made the decision to guarantee some of Bear Stearns' assets as a last resort, and only after exploring all other options.

Mr Reinhart's comments came as the Federal Open Market Committee began the first of two days of meetings yesterday to decide whether to lower interest rates yet further.

A decision is due to be announced at 7.15pm - British time - today. Economists are divided on the issue. Rates have fallen from 5.25pc in September to 2.25pc.

Alan Ruskin, chief international strategist at RBS Greenwich Capital, expects the committee to cut by 25 basis points to 2pc.

"There is a sense that the consumer is besieged by a perfect storm of falling home values, fuel and food price increases, reduced access to credit, and falling employment and income," Mr Ruskin wrote in a research note.

By James Quinn

© The Independent