The Federal Reserve moved to assist a Wall Street investment bank on the brink of bankruptcy to prevent a failure that could have dealt serious consequences to the U.S. economy, Federal Reserve Chairman Ben Bernanke said.
"Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain," Bernanke told the Senate Banking Committee.
Bernanke was the top witness at a hearing called to examine whether the Fed was justified in providing up to $30 billion to facilitate the sale of Bear Stearns to JP Morgan Chase .
The nation's fifth largest investment bank became the biggest victim of a severe credit crunch that has roiled markets since last August and made it harder for consumers and businesses to get credit.
Democrats on the Senate Banking Committee said they wanted to find out what pressures the Bush administration had brought to close the sale and whether big investment banks were getting preferential treatment over millions of Americans in danger of defaulting on their mortgages.
"Was this a justified rescue to prevent a systemic collapse of financial markets or a $30 billion taxpayer bailout for a Wall Street firm while people on Main Street struggle to pay their mortgages?" Senate Banking Committee Chairman Christopher Dodd asked at the beginning of the hearing.
Dodd said he planned to focus on a period of 96 hours including the weekend of March 15-16, in which the federal government took unprecedented actions to "stabilize our markets, to infuse them with liquidity and to prevent additional firms from being swept under the riptide of panic that threatened to have taken hold of our markets."
Bernanke said that if Bear Stearns had been allowed to fail, it would have led to a "chaotic unwinding" of Bearn Stearns investments held by individuals and other financial institutions.
"Moreover, the adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability," Bernanke said.
Meanwhile, JPMorgan Chase chief executive Jamie Dimon planned to tell the committee that the bank would not have offered to buy Bear Stearns if the Fed had not agreed to absorb billions of potential losses.
In prepared testimony, Dimon also said the transaction is not without risk for JPMorgan.
He reiterated that if there is a loss on the assets pledged to the Fed, the first $1 billion of that loss will be borne by JPMorgan alone.
Bear Stearns chief executive Alan Schwartz said in separate prepared remarks that his company was not involved in the negotiations as JPMorgan sought to have the New York Fed loan up to $30 billion to JPMorgan, secured by certain Bear Stearns assets.
"While we at Bear Stearns had some understanding that JPMorgan was seeking this commitment, we were not directly involved in the negotiations between JPMorgan and the government," Schwartz said.
He also said the run on Bear Stearns was initially just a lack of confidence and was not a lack of capital or liquidity.
Bear Stearns is the most high-profile victim of a severe credit crunch that began in August and has forced some of America's largest financial institutions to declares billions of dollars in losses because of bad investments, many in the area of subprime mortgages.
Many economists believe all the credit and housing problems have pushed the country into a recession.
Bernanke, testifying before the congressional Joint Economic Committee on Wednesday, raised the prospect of a recession for the first time since the current slowdown began.
He said it was possible that the overall economy may not grow at all during the first half of this year.
However, he continued to predict that growth will resume in the second half of 2008.