Fed faces political heat over Bear Stearns deal

WASHINGTON (Reuters) - The U.S. Federal Reserve walked into a political firestorm by pledging $30 billion in taxpayer money to guarantee Bear Stearns' assets while struggling homeowners at the core of the financial crisis default on their mortgages.

To be sure, the central bank could hardly sit idly by while the fifth-largest U.S. investment bank collapsed, potentially dragging down other financial firms with it. But by throwing out a lifeline believed to be the biggest single Fed bailout on record, it opened itself up to some pointed criticism.

"As the Fed rides to the aid of Bear Stearns, there is a growing disconnect between the Bush administration's willingness to help Wall Street and its willingness to aid the homeowners facing foreclosure," said Kurt Eggert, a professor at Chapman University's law school in Orange, California.

"When it comes to reducing foreclosures, the Bush administration has adopted a 'What me worry?' attitude, hoping that the market will fix the problem with some cheerleading by federal regulators," he said.

In an emergency Sunday night move, the Fed not only gave its blessing to JPMorgan Chase & Co's plan to buy Bear Stearns for $2 per share -- a tiny fraction of where it was trading on Friday -- but agreed to $30 billion in funding.

Should Bear Stearns' assets lose value, the Fed -- and therefore U.S. taxpayers -- would be on the hook.

Rep. Ron Paul, the Texas Republican and long-time vocal critic of the Fed, said the latest steps smacked of panic and would pile more pressure on the downtrodden U.S. dollar, inflicting added pain on taxpayers already struggling to cope with rising inflation.

"To me, it's an immoral act. It's deceitful and it's stealing from the people who saved money. It should be unconstitutional because technically they have never been given direct authority to create money of out of thin air," he said in a telephone interview.

Sherry Cooper, chief economist at BMO Capital Markets, noted that the Fed's guarantee dwarfed the $3.6 billion deal that it brokered in 1998 to bail out hedge fund Long-Term Capital Management. And that time the money came from a consortium of banks rather than taxpayers' pockets.

POLITICIANS TAKE AIM

While the Fed is supposed to be beyond the purview of partisan politics, many elected officials -- particularly Democrats -- were quick to point out what they viewed as hypocrisy. President George W. Bush, who appointed Federal Reserve Chairman Ben Bernanke, rejected plans to rescue debt-laden homeowners for fear of bailing out speculators, yet he supported the Fed's rescue of Bear Stearns, they noted.

Sen. Charles Schumer, a New York Democrat who has been concerned about financial sector job losses in his home state, said the Fed's move was "smart, timely and threads the needle in just the right way," yet took the Bush administration to task for neglecting homeowners.

"Hopefully, Bear's problems will wake this administration out of its torpor," Schumer said. "If they fail to act to deal with the bull's-eye of the crisis, which is housing, the likelihood of more Bears is too great."

Senate Democratic leader Harry Reid said the Fed's latest actions "appear to shift large risks to taxpayers, who may find themselves on the hook for billions in worthless securities."

"Now that the president has shown his willingness to bail out Wall Street at taxpayer expense, I hope he will drop his opposition to proposals designed to help ordinary homeowners by giving them the same bankruptcy protections available to other Americans," he added.

The White House defended the seemingly contradictory positions by arguing that the Fed did not bail out Bear Stearns, but rather stepped in to minimize market disruption that would have accompanied a disorderly collapse.

"This isn't about bailing anyone out," White House spokeswoman Dana Perino said. "Investors in Bear Stearns are taking large and significant losses in this transaction, and that's not what happens in a bailout."

In a conference call with reporters on Sunday, Bernanke said the Fed's actions were aimed at ensuring that financial firms have access to the cash they need to help keep the fragile economy functioning.

Raghuram Rajan, economics professor at the University of Chicago's Graduate School of Business and former chief economist of the International Monetary Fund, said the Fed may very well have walked into a political storm in a presidential election year, but it had no viable alternative.

"The taxpayers are certainly at risk" he said, adding that the perceived difference between the government's attitude toward Wall Street and Main Street "is going to be played out again and again in this election."

But he noted that a collapsing financial firm posed a more serious imminent threat to the U.S. economy than struggling homeowners. While a wave of mortgage defaults is certainly harmful, the failure of just one bank could lead to a dangerous domino effect on Wall Street.

Rajan said the lesson to be learned was that more supervision was needed for the banking system and non-banking groups involved with consumer lending.

"You can't keep saying the market will take care of itself," he said.

(Editing by Leslie Adler)