I believe an important factor in the Fed’s decision to help JP Morgan shore up Bear Stearns is the size of Bear’s prime brokerage business. A lot of hedge funds depend on Bear to support parts or all of their trading through clearing and custodial services and lending. While I am sure that some of them have already made contingency plans or migrated away, there would still have been a huge and unpredictable ripple effect as hedge funds might have been forced to unwind positions or been cut off from liquidity in their portfolios. Next week will be a scary one in the markets as folks are unlikely to trust that Bear can survive and will be worried about other large institutions.
Addendum: Gretchen Morgenson argues in the NYT that the Fed bailout of Bear goes too far. I would agree if this were designed to keep Bear around as an independent business, but I believe this is only to provide an orderly transition. When a business is a platform for other businesses (even if they are hedge funds) the consequences of a panic shutdown would be a lot more dramatic than for a single bank even if it is a large bank.
