In order to understand the underlying rationale for Bernanke’s actions, we must apply what we know about systemic risk. Due to the fact that the plight of Bear Stearns was a result of it being highly leveraged, there are various other counterparties such as brokerage firms, commercial banks, pension funds, all entities that financed much of Bear Stearns’s investments that would be directly/ indirectly affected by its collapse. In this case containing systemic risk was the main concern for officials at the Fed. An adverse effect of Bear Stearns filing for bankruptcy would have been exposing these counterparties to a significant amount of systemic risk, and triggering a potential “domino effect” that would have roiled the entire financial market. Bernanke stated in his April 3, 2008 testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate that the issues raised by the Bear Stearns situation would raise difficult questions of public policy. Normally, the Fed would allow the market to determine which companies survive and which do not. However, the Bear Stearns calamity raised issues that went far beyond the fate of one company. Bernanke stated that the sudden failure of Bear Stearns would have led to a chaotic unwinding of positions in the markets within which Bear Stearns participated and could have severely shaken the confidence of the entire market.54"The company’s failure would have cast doubt on the financial positions of some of Bear Stearns’ thousands of counterparties."
26Given the exceptional pressures on the global economy and financial system, the adverse effects of a default by Bear Stearns could have been severe and extremely difficult to contain. Moreover, a default would not have been confined to the financial system "but would have been felt broadly in the real economy through its effects on asset values and credit availability." In order to prevent a disorderly failure of Bear Stearns and the severe consequences for the market and the broader economy, the Fed, in consultation with the Treasury Department, agreed to provide funding to Bear Stearns through JP Morgan Chase. JP Morgan agreed to purchase Bear Stearns and assumed Bear’s financial obligations supported by a line of credit offered by the Federal Reserve.55The reaction of the Fed drew some varied reactions from various stakeholders within the industry. Some finance experts have voiced concern over what they said was a “bailout” and the risky precedent that may have been set. Furthermore, lawmakers have criticized the Fed's willingness to provide 29 billion dollars in “taxpayer” guarantees in return for collateral from Bear Stearns.56Some of the collateral involves mortgage backed securities that have dropped in value.