Whether or not the Federal Reserve has done the right thing in fostering the sale of Bear Stearns is becoming a great debate of our times, a sort of template in which to measure one’s economic sensibilities. My opinion is that the Fed did the wrong thing, in principle, because it was trying to overcome a “natural” development. Free markets get the results that the facts demand, and intervening to outpace those developments is bound to complicate the effects.

I’m also of the opinion that the Fed did everything right, as a matter of policy, because that’s what the Fed is chartered to do: intervene to avert catastrophe. (A sarcastic, explanation of this point is found here.)

If you have not followed the Bear Stearns tale, this is it: Bear Stearns was an investment bank — i.e., an institution that finances businesses and investment activities, and makes money by its fees and transactions. It has been hugely successful in the past decade, as financial transactions have reached indescribable levels of complexity, and value, of course.

During this period, the Federal Reserve’s governing philosophy has been to encourage individual’s to create more personal wealth — thinking this would spur consumer activity and open global markets, which would spur greater growth. This much was correct.

But, creating wealth for individuals required some sort of collateral – and that typically turned out to be homes. Buying and selling homes drove up home values, which created even more opportunities because it allowed home owners to borrow the value of their homes to finance whatever consumer activities they chose — not just homes, but cars, boats, computers, entertainment systems, $6.00 coffees, luxury vacations, pedicures, cigars, anything you want.

Keeping track of all the financing for this activity called for more sophisticated financial techniques — not just taking profits on commodity futures or currency trades, but by esoteric calculations. These were known as “derivatives,” contracts between parties where the payment is based on some near-term benchmark — how far below a six-month futures contract for frozen concentrated orange juice will the actual trading price fall? Most derivatives were even more obscure, and more risky.

And yet, that’s how Bear Stearns made its money. To offset such risks and to keep the game going it needed to keep the money flowing. The money flowed out of consumers, so to keep them primed with cash the home-loan financing and refinancing had to continue. To make it continue, more loans carrying higher and higher risks had to be extended. Failure, to some extent, was inevitable.

But this whole approach to economic growth, from the Federal Reserve down to the lending officers, seemed to ruled out failure as a real possibility.

Maybe failure seemed so improbable because so much of the risk these people understood was not real, but theoretical. It was rooted in calculations, and when the likelihood of failure emerged from their calculations they could define a new derivative to contract, and that would offset the previous calculation.

The metalcasting market had two real examples of risk and reward this week: Cymat Technologies Ltd. declared its “stabilized aluminum foam” technology has been successfully applied to a lightweight structural component for a high-performance automotive manufacturer; and AmeriCast Technologies expanded again with its purchase of A.G. Anderson Ltd., a ferrous foundry and patternmaker in London, ON.

These stories illustrate the rewards for imaginative thinking, reliable research, dedicated process development, business skill, and long-range vision. No doubt each of these developments also involved lots of failure and disappointment before achieving these results. Failure is part of the process.

By seeking to avoid failure we cheat the process and we limit our understanding of the facts. The Fed’s effort to cushion the fall of Bear Stearns may have prevented a stock market tumble, but it has made it more difficult to know how severe is the financial market’s capital shortage. And, that is punishing strong companies by trapping them in an unrewarding market. Worse yet, it has encouraged more corrective measures from the federal government, which can only muddle things more.

Likewise, federal efforts to “fix” the other half of this problem — homeowners defaulting on their mortgages — will slow the market’s ability to correct the problem. It will also be unfair to the millions more homeowners who
have not defaulted, and whose homes will be devalued by the ongoing market malaise.

There is always danger in exaggerating the importance of financial and economic concerns, because free-market developments don’t follow the rationale of individuals: my excitement, or discouragement, or doubt may be shared by you and millions of others, but that doesn’t ground our emotions in facts.