Perhaps the most insightful comment made during the first session of Thursday's ultra-marathon Senate Banking Committee hearing investigating the near collapse of Bear Stearns came from Sen. Richard Bennett, R-Utah.
But I like the phrase that comes from a specialist who looked at this. He said, "20 years ago the Fed would have let Bear Stearns go bust; today, it is too interlinked to fail." Not too big to fail, too interlinked to fail. And that, again, is the world of derivatives, the world of hedge funds, the world that we all come together.
Too interlinked too fail. No more essential point could be made about the reality of modern financial markets. The proliferation of a vast array of complex financial instruments that are sliced and diced and recombined in a bewildering variety of forms and bought and sold and traded by thousands of parties across the globe has woven everyone so tightly together into one big knot that, to brutally paraphrase Benjamin Franklin, if one party hangs, all the counterparties will assuredly hang together. Which makes Fed chairman Ben Bernanke's comment, later in the session, "If you want to say we bailed out the market in general, I guess that's true. But we felt that was necessary, in the interest of the American economy."
Bear Stearns didn't get bailed out. The entire system of globally interlinked financial markets got bailed out. Capitalism got bailed out. Cheap at the price, if you ask me.
On the one hand, this makes Sen. Jim Bunning's question to Federal Reserve Bank president Timothy Geithner all the more relevant.
How did we get to the point that the failure of one firm can bring us to the edge of collapse, our whole financial markets? We know the Fed and others did not do their job in regulating lending practices and supervising the risks banks were taking on, but how do you let the entire financial system become so fragile that it could not tolerate one failure?
How indeed? But Bunning -- who had earlier claimed that bailing out Bear Stearns was "socialism" -- was also being extraordinarily disingenuous (not to mention insulting when he attempted to browbeat Geithner into submission without allowing him to answer the question). Sure Alan Greenspan deserves some of the blame for where we are today, but by no means all of it. Indeed, a good case can be made that no one in the regulatory community has done more than Tim Geithner in both warning against the dangers inherent in the unfathomable complexities of modern finance and in trying to get Wall Street to straighten its affairs. We got where we are today because a succession of administrations specifically refused to exercise more oversight over the "innovations" that investment banks like Bear Stearns were cooking up. Congress could also have required more transparency and accountability, but dropped the ball.
Instead, both the Clinton and Bush administrations and Congress accepted Wall Street's plea to let them proceed with a light regulatory hand, and accepted the argument that new derivative instruments, such as credit default swaps, would increase the stability of the overall financial system by spreading risk more broadly. We all now know how ridiculous that argument turned out to be. The invisible hand of Wall Street ended up slapping itself silly. Now we're going to need a little more socialism to clean up the mess.