So now that we understand Bear Stearns’ business a little better we can now look at the two opposing arguments as to whether or not the government and/or the Federal Reserve should have gotten involved in trying to save the firm.

The first argument basically goes that the bank and the financial markets got themselves into this situation so they should be the ones who get themselves out of it. There are two parts to this argument:

1. When the government intervenes it is normally the taxpayer that gets stuck with the problem which in these types of cases can mean very large losses that taxpayer money makes up for. So the first part of this argument is why should taxpayer money be used to bail out a financial institution that created their own problems which the taxpayer had nothing to do with?

2. When the government intervenes it creates something which is known as moral hazard, which makes a similar or worse situation than you have just bailed out more likely to happen in the future. Moral Hazard is a situation where individuals and companies are more reckless than they normally would be because history has shown that if they screw things up too bad then someone will come along and save them. So the argument here goes that because history has shown that the government will bail these large institutions out when they get into trouble, they act more recklessly than they otherwise would, making a crisis like this or even worse more likely to happen in the future.

The other side of this argument which we began to look at in part two of this series is that if a financial institution of this size is allowed to fail, especially in the current environment where things are already on edge, then the whole financial system will come crashing down on itself. There are basically two sides to this argument as well which are:

1. If this where allowed to happen then the problems would not be contained just to the financial institutions who got themselves into this mess, but would also drastically affect the economy for the worse, and therefore the average citizen would be affected as well. So the argument here goes that government and/or Federal Reserve intervention is warranted because the consequences and hit to the average taxpayer of letting an institution that is this intertwined into the financial system fail would be much more drastic than the bill for any action.

2. The second argument here in this particular case, is that the bank is now effectively out of business, a lot of the employees are going to loose their jobs, and billions of dollars have been lost in shareholder wealth so the danger of a moral hazard of any consequence being created as a result of the bailout is relatively limited.

There are many debates surrounding the above issues and you can expect to see this in the news for many months if not years to come. As this is the case we will be actively following and discussing the different points in the debate in the subprime learning center at InformedTrades.com so we hope to see you there.

That completes this video. In our next video we are going to look at just how the government did intervene in this instance with a look at the days leading up to the fall of Bear Stearns. This is where it really gets interesting so we hope to see you in our next video.

As always if you have any questions or comments please leave them in the comments section below, and have a great day!

hi david,

i don't know if you will post any additional videos on the bear stearns (BS) issue, but i have one question (maybe similar to that of Daveextra on youtube.com .

i have read many times that the fed + jp morgan bailed out / rescued / etc. BS ...

but is it really a rescue when the shareholders got just 2 USD per share? is it for the shareholders of BS not better to see their company go bankrupt and get the fair value for remaining BS assets? you've told in one of your BS-videos that just the single building (BS headquarters in NY) is worth four-times the take-over price paid by jp morgan ... and that building is for sure not the one and only BS asset, is it?

why did the BS shareholder accepted that strange take-over? the other recent examples microsoft/yahoo, google/you tube, bhp billiton /rio tinto, ... seems to 'work' different way, don't they?

it looks like a big big fraud (BBF) for me and i'm so sorry for the poor BS shareholders (+ employees).

thanX + greetings from rainy munich,
jaro

Hi Jaro,

This is a legitimate question that a lot of people are asking and something that we are going to be exploring in our videos to come.

A couple of points of clarification here however. Firstly the shareholders have not approved this deal yet and one of the things that is being debated now is whether or not they will.

Secondly as we will look into in our coming videos things are a little more complicated as they seem because the first people to get paid in a situation like this if the company goes bankrupt is the creditors of the firm. The shareholders get paid after everyone else so what the debate will basically come down to with the shareholders is that if the firm is allowed to go bankrupt will the shareholders receive more or less than $2 per share after everyone else is paid?

If they will receive more then what you are likely to see is either JP Morgan upping its purchase price in order to get shareholder approval or the shareholders rejecting any offer that is less than they feel they will get if the company is liquidated. We will be discussing each of these scenarios so stay tuned.

I encourage any other thoughts on this to be posted below.

Best Regards,
Dave

thanX a lot + i'm looking forward to read/see more about this issue + other postings about the current shaky state of so many financial institutions and its direct impact on financial markets, western currencies, gold, inflation and economy in general ...

bye-bye,
jaro.