Bernanke and the four Fed governors voted yesterday to become creditors to Bear Stearns Cos., a securities firm that isn’t a bank, by invoking a law that hasn’t been used since the 1960s. Three days earlier, the Fed said it would swap Treasury notes on its balance sheet for privately issued mortgage-backed securities held by Wall Street firms.
“It’s a re-drawing of the relationship of the Federal Reserve with the rest of the financial system,” said Vincent Reinhart, former director of the Division of Monetary Affairs at the Board. Risks of so-called moral hazard, where firms will now come to count on bailouts by a federal agency, “are considerable,” he said.
I don’t think taxpayers should bailout failing businesses and I don’t make an exception for banks. However if a central bank is going to offer finance to bail out a business such as this then I think they should do so only on the condition that they receive an equity stake (which they should offload on the market at some later point) and that the board sack the CEO. This would at least mitigate some of the moral hazard.