http://www.bloomberg.com/apps/news?pid=20601087&sid=aZA_RWY3IJ2...

After months of litigation and political scrutiny, the Federal Reserve yesterday ended a policy
of secrecy over its Bear Stearns Cos. bailout.

In a 4:30 p.m. announcement in a week of congressional recess and religious holidays, the central bank released details of securities bought to aid Bear Stearns’s takeover by JPMorgan
Chase & Co. Bloomberg News sued the Fed for that information.

The Fed’s vehicle known as Maiden Lane LLC has securities backed by mortgages from lenders including Washington Mutual Inc. and Countrywide Financial Corp., loans that were made with
limited borrower documentation. More than $1 billion of them are
backed by “jumbo” mortgages written by Thornburg Mortgage Inc.,
which now carry the lowest investment-grade rating. Jumbo loans
were larger than government-sponsored mortgage buyers such as
Fannie Mae could finance -- $417,000 at the time.

“The Fed absorbed that risk on its balance sheet and is now seen to be holding problematic, legacy assets,” said Vincent Reinhart, a resident scholar at the American Enterprise
Institute in Washington who was the central bank’s monetary-
affairs director from 2001 to 2007. “There is both an
impairment to its balance sheet and its reputation.”

The Bear Stearns deal marked a turning point in the financial crisis for the Fed. By putting taxpayers at risk in financing the rescue, the central bank was engaging in fiscal
policy, normally the domain of Congress and the U.S. Treasury,
said Marvin Goodfriend, a former Richmond Fed policy adviser who
is now an economist at Carnegie Mellon University in Pittsburgh.

‘Panic’ Cause

“Lack of clarity on the boundary between responsibilities of the Fed and of the Congress as much as anything else created panic in the fall of 2008,” Goodfriend said. “That created a
situation in which what had been a serious recession became
something near a Great Depression.”

Central bankers also created moral hazard, or a perception for investors that any financial firm bigger than Bear Stearns wouldn’t be allowed to fail, said David Kotok, chief investment
officer at Cumberland Advisors Inc. in Vineland, New Jersey.

Policy makers’ resolve was tested months later by runs against the largest financial companies. Lehman Brothers Holdings Inc. collapsed into bankruptcy in September 2008. The
ensuing panic caused the Fed to take even more emergency
measures to push liquidity into markets and institutions. It
rescued American International Group Inc. from collapse and
allowed Goldman Sachs Group Inc. and Morgan Stanley to convert
into bank holding companies, putting them under greater
oversight by the central bank.

Early Failure

“Letting somebody fail early would have been a better choice,” Kotok said. “You would have ratcheted moral hazard lower and Lehman wouldn’t have been so severe.”

The Bear Stearns assets include bets against the credit of bond insurers such as MBIA Inc., Financial Security Assurance Holdings Ltd. and a unit of Ambac Financial Group, putting the
Fed in the position of wagering companies will stop paying their
debts.

The Fed disclosed that some of Maiden Lane’s assets were portions of commercial loans for hotels, including Short Hills Hilton LLC in New Jersey, Hilton Hawaiian Village LLC in Hawaii,
and Hilton of Malaysia LLC, in addition to securities backed by
residential mortgages.

More than a year after Washington Mutual, the largest U.S. savings and loan, was purchased by JPMorgan Chase in a distressed sale arranged by the Federal Deposit Insurance Corp.,
the home loans that helped bring down the Seattle-based thrift
live on in the Maiden Lane portfolio.

Lending Standards

For example, 94 percent of the mortgages in one security, called WAMU 06-A13 2XPPP, required limited documentation from borrowers, meaning the lender often didn’t ask customers for
proof of their incomes. Almost 10 percent of the borrowers whose
mortgages make up the security have been foreclosed on, and
almost a quarter are more than two months late with payments,
according to data compiled by Bloomberg.

The portfolio also includes $618.9 million of securities backed by Countrywide, mortgages now rated CCC, eight levels below investment grade. All the underlying loans are adjustable-
rate mortgages, with about 88 percent requiring only limited
borrower documentation, according to Bloomberg data. About 33.6
percent of the borrowers are at least 60 days late. Countrywide
is now part of Charlotte, North Carolina-based Bank of America
Corp.

CDO Holdings

Maiden Lane has $19.5 million of securities from a series of collateralized debt obligations called Tropic CDO that are backed by trust preferred securities of community banks and
thrifts. CDOs are investment pools made up of a variety of
assets that provide a flow of cash.

Trust preferred securities, or TruPS, have characteristics of debt and equity and their interest payments are tax- deductible.

The securities created by Bear Stearns are rated C, one level above default, by Moody’s Investors Service and Fitch Ratings.

CDO securities have tumbled in value as banks are failing at the fastest rate in 17 years, according to data compiled by Bloomberg. The average price of TruPS CDO debt of this rating is
pennies on the dollar, according to Citigroup Inc.

“The trust of the taxpayer was abused,” said Janet Tavakoli, president of Chicago-based financial consulting firm Tavakoli Structured Finance Inc. CDOs rated CCC and lower “have
a high likelihood of default,” she said.

Bernanke Defense

Chairman Ben S. Bernanke defended the Bear Stearns deal as a rescue of the financial system. He said in a speech at the Kansas City Fed’s annual Jackson Hole, Wyoming conference in
August 2008 that a sudden Bear Stearns failure would have caused
a “vicious circle of forced selling” and increased volatility.

“The broader economy could hardly have remained immune from such severe financial disruptions,” Bernanke said in the speech. The Fed chief, who took office in 2006 and began his second term
as chairman this year, also has repeatedly called for an
overhaul of financial regulations that would allow authorities
to take over a failing financial institution and oversee an
orderly unwinding of its positions.

Bernanke said last year that nothing made him “more angry” than the AIG case, blaming the insurer for making “irresponsible bets” and a lack of regulatory oversight for the debacle.
Officials “had no choice but to try and stabilize the system” by
aiding the firm in September 2008, he said.

Yesterday’s release by the Fed, through its New York regional bank, also identified securities acquired in the bailout of AIG held in vehicles known as Maiden Lane II and III.

Market Value

Assets in Maiden Lane II totaled $34.8 billion, according to the Fed, which set their current market value in its weekly balance sheet at $15.3 billion. That means Maiden Lane II assets
are worth 44 cents on the dollar, or 44 percent of their face
value, according to the Fed.

Maiden Lane III, which has $56 billion of assets at face value, is worth $22.1 billion, or 39 cents on the dollar, according to the Fed’s weekly balance sheet. A similar
calculation for the Bear Stearns portfolio couldn’t be made
because of outstanding derivatives trades.

“The Federal Reserve recognizes the importance of transparency to its financial stability efforts and will continue to review disclosure practices with the goal of making
additional information publicly available when possible,” the
New York Fed said in yesterday’s statement.

Deal With Chase

The central bank said it reached agreement on “issues of confidentiality” for the assets with JPMorgan Chase, which bought Bear Stearns in 2008, and AIG. New York-based JPMorgan
and AIG would incur the first losses on the portfolios.

Joe Evangelisti, a spokesman for JPMorgan, and Mark Herr, a spokesman for AIG, declined to comment.

In April 2008, Bloomberg News requested records under the federal Freedom of Information Act from the Fed’s Board of Governors related to JPMorgan’s acquisition of Bear Stearns. The
central bank responded that records retained by the New York Fed
“were proprietary records of the Reserve Bank, and not Board
records subject” to the request, court records show.

Bloomberg filed suit in November 2008 in U.S. District Court in New York, challenging the Fed’s denial, as well as the denial of a separate request made in May 2008, seeking records
of four other emergency lending programs.

The district court held that the Fed should release documents related to those four programs, and should search documents held by the New York regional bank to determine
whether any of them should be considered records of the board of
governors.

The U.S. Court of Appeals on March 19 upheld the district court’s ruling on the lending programs.

Representative Darrell Issa of California said in a statement that yesterday’s disclosure may “signal a new willingness to cooperate with Congress as we investigate how
these bailout deals were structured and what the decision making
process entailed.”