RENEE MONTAGNE, host:
The Federal Reserve is widely expected to cut interest rates today in an effort to shore up the sagging economy. That's on top of the extraordinary action the Fed took in response to the collapse of the investment bank Bear Stearns. Some observers praised the Fed for its aggressive moves to prevent a broader meltdown in financial markets. Others say the Fed is not doing enough to address the underlying problem.
NPR's Scott Horsley reports.
HORSLEY: The Federal Reserve tried to douse a financial fire yesterday by turning the credit spigot wide open. The Fed lowered the interest rate on loans it makes directly to banks, and agreed to lend money to securities dealers for the first time since the 1930s.
Over the weekend, the Fed also gave quick approval to JPMorgan Chase's purchase of the struggling Bear Stearns investment bank. Treasury Secretary Henry Paulson says that was a much better outcome than allowing Bear Stearns to go bankrupt.
Secretary HENRY PAULSON (Department of Treasury): We place a high priority on the orderliness of our financial markets. Bear Stearns had a liquidity crisis. And so we felt it was very important that this be resolved as a way to minimize impact on our economy.
HORSLEY: Senate Majority Leader Harry Reid complained that the Fed was shifting big risks from Wall Street on to taxpayers by funding the Bear Stearns purchase with a $30 billion loan, backed only by risky securities. Paulson insists the Fed's action was designed to protect financial markets, not bail out investors.
Mr. PAULSON: What I would say is if you were to ask the Bear Stearns shareholder in terms of what has happened to their value, I don't think any of them would think that this has been a good outcome for them.
HORSLEY: Bear Stearns investors lost billions of dollars in a matter of days.
Still, Business Professor Peter Morici of the University of Maryland says if the Fed was going to provide more credit to investment banks, it should have gotten more in return.
Professor PETER MORICI (Business, University of Maryland): The banks got into this mess by practicing faulty banking, making bad loans and then wrapping them into faulty securities that the bond market will no longer accept. And the Fed has thrown open the discount window, and it hasn't gotten any commitments from the banks to clean up. It's as if the banks got all their terms and the Fed got nothing.
HORSLEY: Morici says investment banks need to get out of the risky business of creating exotic securities and go back to making safer, albeit less profitable, plain vanilla bonds. By accepting risky securities as collateral for debt, Morici says the Fed is merely putting off the eventual day of reckoning.
Prof. MORICI: Right now, we're in a holding action. The Fed is holding this bad paper, hoping that times will get better, that housing prices will rise. We need to restructure that debt, write off the losses where we have to - kind of what the resolution trust did back in the days of the savings and loan debacle.
HORSLEY: Fed watcher Doug Roberts agrees. This week's credit infusion won't cure everything that's ailing Wall Street, but he says it's an important step. Roberts, who's chief investment strategist for Channel Capital Research, applauds the Fed for setting aside its fears of inflation or a bailout long enough to keep the credit flowing.
Mr. DOUG ROBERTS (Chief Investment Strategist, Channel Capital Research): When you have, let's say, an injury, the most important thing is really to keep the patient alive and stabilize the patient as opposed to worrying about the need for plastic surgery. You're performing triage on the situation.
HORSLEY: Without the Fed's quick action, Roberts says, the credit crunch at Bear Stearns could have triggered a cascade effect.
Mr. ROBERTS: All of a sudden, another entity starts to have problems. And people all of the sudden start pulling money and you have a massive contraction in the system. It kind of just freezes up.
HORSLEY: The Fed's actions have not completely put those fears to rest. JPMorgan Chase's stock rose yesterday, but many other financial stocks were down as investors tried to figure out if there's another Bear Stearns waiting to fall.
Scott Horsley, NPR News.
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