Why the Bear Sterns bailout was a good thing for small investors

Monday, April 07, 2008 by Dave Winer.

First, a caveat, I am far from a financial expert, so I may have some of this wrong, if so, please set me straight. 

The cable news shows didn't do a good job of covering the Fed's bailout of Bear Stearns, and as a result there's a misunderstanding about whether it's good or bad. It is, imho, an unqualified good thing because it saved us from a run on the banks, something we haven't seen since the Great Depression of the 1930s.  

First to be clear, a run had already started. That's what was going on with Bear Stearns.  

A run is a form of panic. You hear a rumor that your bank is in trouble, so you go down to the bank to withdraw all your savings. You tell a few of your friends, and they tell a few, and all of a sudden the bank's reserve is gone (banks don't keep all your money, they lend most of it out, that's how they make money). Meanwhile one of your neighbors who keeps her savings at a different bank gets the idea that her money might not be safe, so she goes to withdraw all her money, tells her friends and so on, and eventually their reserve is depleted and they have to refuse requests for withdrawals.  

A bank run a viral thing, and once one gets going, there's no way to stop it. But the US govt did do something to prevent runs, with the FDIC, a government entity that insures deposits. This really did prevent runs, we haven't had one since.  

Now here comes a new form of bank, offering better returns than the insured bank accounts, people feel safe putting their money there, but they are not insured. Like Bear Stearns, where a run started on March 11 of this year, putting the Fed in a difficult position, stop it, by backing the accounts, or let it run. Thankfully they did the right thing, and stopped it. Why? Because if they hadn't, every one with a savings account at any brokerage firm might have lost his or her savings! We came perilously close to a complete meltdown, and most people don't even know it. 

I have a theory why they aren't explaining this on CNN, Fox and MSNBC -- and they may be doing the right thing -- that by explaining how close we came to an across-the-board run they might precipitate one. Now the government is acting, we hope quickly, to get FDIC-like insurance in place for brokerage accounts, and charging the companies appropriately for it, so they pay in advance (unlike Bear Stearns), so the general taxpayers of the US don't end up footing the bill, and hope that while this system is being put in place, everyone who has their savings in a brokerage feels comfortable leaving them there, at least for the time-being.  

But note that Bear Stearns didn't get the bailout, the people with deposits there got it. True, the rest of the brokerage industry got a reprieve, but that didn't cost us anything, at least not yet. 

PS: It's a Wonderful Life features a bank run.