Editorial: Bernanke's Bear Market

That's Bear with a capital B, as in Bear Stearns, the Wall Street titan whose credit problems on Friday triggered another broad stock market selloff. Credit markets are continuing to re-price risk across the board, and investors are wondering when the next financial corpse will float to the surface. So naturally the wounded are clamoring for the Federal Reserve to ride to the rescue with easier money when it meets tomorrow, even though the Fed helped create this mess. Credit panics are never pretty, but their virtue is that they restore some fear and humility to the marketplace. That lesson is certainly being relearned at Bear Stearns, a venerable outfit that was supposed to be a whiz in the fixed-income market. But two of its subprime mortgage hedge funds have cost investors dearly, and Standard & Poor's piled on Friday by downgrading Bear's financial outlook to negative from stable. Bear executives were alarmed enough to host a conference call with Wall Street analysts disclosing what they have done to shore up the firm's balance sheet. But the call only alarmed investors more broadly when the Bear execs moaned that today's fixed-income market is the worst in decades. Yesterday the company sacked the head of its capital markets business, and that might not be the end of the carnage. Last week amounted to an investor run on Bear, and regulators need to watch closely and perhaps clean house so Bear's problems are contained. The Bush Administration hasn't had to show this kind of financial plumbing capacity to date, and we hope Hank Paulson's Treasury is on the job. The big question is whether this credit correction is destined to become a full-blown credit crunch, damaging the larger economy. There's not much doubt the mortgage market is getting worse, with the pain moving up the income chain from subprime loans. American Home Mortgage stopped lending last week, and the Sowood Capital Management hedge fund got caught by wider credit spreads. The ISI Group's Andy Laperriere, who has been ahead of the housing curve, is predicting a further mortgage crunch "worse than most pessimistic assumptions." In these kinds of financial corrections, it pays to expect more surprises. Yet overall credit spreads are hardly out of line with historical norms. Spreads in the high-yield debt market have moved in the 5% range from 2.5% to 3%. What was truly out of whack was how narrow they became for so long. The rapidity of this return to normalcy is creating troubles, but they so far don't seem to signal the kind of liquidity crunch we saw with the Asian crisis of the late 1990s, or the dot-com crash of 2001. The global economy is booming, with every country save for a couple of despotisms growing. The so-called emerging economies of Brazil, China and India are growing fast enough that the U.S. consumer isn't the world's only growth engine. And for all of the credit worries, last Friday's U.S. employment report for July showed a slowing but still healthy job market. The jobless rate rose to 4.6% but weekly jobless claims have fallen of late. The biggest decline in jobs came from government. Meanwhile, both services and manufacturing continue to expand, with the latter benefitting from exports feeding the global boom. Which brings us to the Fed, and its Open Market Committee meeting tomorrow. As always amid a credit turn, the pleas for easier money are rising. We're even hearing nostalgic cries for the return of Alan Greenspan, who is remembered fondly for supplying liquidity during the credit crises of his era. But what these cries forget is that the Greenspan Fed is one reason for the current mortgage mess. It's tempting to blame Wall Street and other bankers for all those bad residential loans, and they are paying the price now. But they were also lending into a housing asset bubble fed by easy monetary policy. Risky mortgages always look better when home prices look like they'll never decline. Current Fed Chairman Ben Bernanke was along for the Greenspan ride, so he's hardly blameless. No doubt he'd love to play the hero role now, signaling easier money this week. However, he'd have to do so at a time when the dollar is weak, oil is at $78 a barrel, and commodity prices in general are roaring. Mr. Bernanke and the Fed might have more room to maneuver this week had they been tighter earlier. But now they can't afford to ignore global dollar weakness. The run on Bear Stearns would look like a Sunday stroll compared to a global run on the dollar.