Guess who’s getting a bailout?

ON MARCH 19, JPMorgan Chase CEO Jamie Dimon joined Bear Stearns CEO Alan Schwartz to face a group of 400 stunned Bear executives. Five days earlier, Bear Stearns, one of Wall Street's five largest investment banks, had lost $17 billion of wealth, triggering the biggest financial panic since the Great Depression.

Bear approached complete collapse before the U.S. Federal Reserve stepped in to rescue it by engineering the emergency funding that allowed commercial giant JPMorgan to take over Bear, the first time the Fed has engineered such a rescue since the 1930s.

Dimon and Schwartz somberly explained to the assembled executives, "We here are a collective victim of violence"--as if the investment firm had been beaten and robbed by a gang of creditors instead of aiding and abetting its own rapid demise.

It is impossible to feel sympathy for the situation now facing Bear's high-flying management team. Schwartz continued to issue public assurances of Bear's solvency until the day the firm collapsed.

Current non-executive Chairman and former CEO Jimmy Cayne, who achieved billionaire status a year ago, has spent the better part of the last year attending to his hobby of card playing, and was indeed at a bridge tournament in Detroit while the value of Bear stocks was evaporating last week.

Even now, Cayne will walk away with more than $16 million while JPMorgan has already reportedly made lucrative offers to hire top Bear bankers and brokers. Under pressure from Bear's board of directors, Morgan sweetened the pot, raising its initial offer of $2 per share to $10 on March 24--again winning praise from Schwartz.

Bear's 14,000 employees, in contrast, have fared poorly. They own an estimated one-third of its total shares, which only last year peaked at $171.50 per share. As Bear sheds half of its workforce, many will face financial ruin. The cost to workers whose pension funds have been invested in Bear Stearns is unknown.

THE BEAR Stearns debacle is just the latest phase of the financial distress triggered by the sub-prime mortgage crisis last July, and it is unlikely to be the last. In a moment of candor, former Bear board member Stephen Raphael summarized the unfolding crisis facing the U.S. financial system, telling the Wall Street Journal, "Wall Street is really predicated on greed. This could happen to any firm."

The current financial panic is based on the knowledge that since the 1990s, Wall Street investment firms have orchestrated get-rich-quick schemes predicated on a model of betting, using the odds of Russian Roulette, in which managers offer investors opportunities to make fast money in high-risk transactions--through hedge funds, Structured Investment Vehicles (SIVs) and other "innovative" derivative instruments such as Collateralized Debt Obligations (CDOs).

These investment schemes, which operate free of government regulation or oversight, have been described as a "shadow banking system," which operates in virtual secrecy, accountable to no one, based on mathematical models investors could not possibly understand and leveraged by borrowed money many times the actual money invested--at terms always skewed in favor of the short-term gains for managers.

The wheels for the current financial perfect storm were set in motion many years before the sub-prime mortgage crisis hit, and the Bush administration deserves no credit.

As one of his last acts as president in December 2000, Bill Clinton signed into law the Commodity Futures Modernization Act, which formally deregulated companies sponsoring derivatives schemes. The legislation was sponsored by Texas Republican Phil Gramm, now the vice chairman of the Swiss investment firm UBS.

As Financial Times columnist Martin Wolf noted, "With the 'right' fee structure, mediocre investment managers may become rich as they ensure that their investors cease to remain so."

On March 13, the Carlyle Capital Corporation hedge fund collapsed with debts amounting to 32 times its capital. The significance of Carlyle's demise was overshadowed by the Bear Stearns debacle. Yet, as Wolf argued, such vehicles are "bound to attract the unscrupulous and unskilled, just as such people are attracted to dealing in used cars...

"It is in the interests of insiders to game the system by exploiting the returns from high probability events. This means that businesses will suddenly blow up when the low probability disaster occurs, as happened spectacularly at [the U.K. bank] Northern Rock and Bear Stearns."

Two of Bear Stearns' hedge funds went under in the last six months due to disintegrating sub-prime mortgage holdings. But as the recent string of Wall Street crises exposed, the shadow banking system has increasingly intersected with commercial banks. It is difficult to know where one ends and the other begins, since banks have been allowed to keep such investment vehicles off their balance sheets--legally.

As the New York Times reported on March 23, "[D]erivatives are buried in the accounts of just about every Wall Street firm, as well as major commercial banks like Citigroup and JPMorgan Chase."

In recent years, mortgages have been carved up and bundled into investments that changed hands before the ink was dry, as investment banks and other vehicles bundled the debt and passed it on in a global game of "hot potato" that passed on risks to the entire international banking system.

USING UP to $30 billion of taxpayer money--and without congressional approval--the Federal Reserve instantly mustered a bailout plan for Bear Stearns. But no relief is in sight for the more than 20 million homeowners whose mortgages are expected to exceed the value of their houses by the end of the year--roughly one-quarter of U.S. homes, according to economist Paul Krugman--or the more than 2 million facing foreclosure within the next two years.

While house prices have already have dropped 5 to 10 percent, most economists predict they will drop by another 20 percent or more over the next two years. But as Krugman notes, regional disparities will be devastating: "In places like Miami or Los Angeles, you could be looking at 40 percent or 50 percent declines."

Yet as the Financial Times recently observed, working-class homeowners are the most vulnerable to market trepidations: "[R]emarkably, bankruptcy laws currently provide that almost every form of property (including business property, vacation homes and those owned for rental) except an individual's principal residence cannot be repossessed if an individual has a suitable court-approved bankruptcy plan."

Thus far, the Bush administration's response has promoted a "tough love" approach toward delinquent homeowners lured into obtaining mortgages by predatory lenders during the heyday of the housing boom. Preventing housing prices from falling will prolong the agony, according to Treasury Secretary Henry Paulson: "We need the correction."

Even the Wall Street Journal observed this glaring discrepancy, commenting, "Why a 'bailout' for Wall Street, and none for homeowners? Treasury Secretary Paulson is trying...[to defend] what the government just did: 'Given the turbulence, we've had in our markets and the way that sentiment has swung so hard toward 'risk adversity,' our top priority is the stability of our financial system, because orderly, stable financial markets are essential to the overall health of our economy.'"

Those expecting a Democratic Party victory in November to reverse Wall Street forces must reconsider.

"Hillary Rodham Clinton and Barack Obama, who are running for president as economic populists, are benefiting handsomely from Wall Street donations, easily surpassing Republican John McCain in campaign contributions from the troubled financial services sector," noted the Los Angeles Times.

By the end of 2007, 36 percent of the U.S. population's disposable income went to food, energy and medical care, more than at any time since 1960, when records began. And that doesn't count, crucially, housing costs. The other shoe has yet to drop.