On Sunday, March 16, the Federal Reserve crossed a big line directly bailing out a non-depository financial institution and our fifth largest investment bank, Bear Stearns, for the first time since the Depression. The Fed forced Bear Stearns out of existence by loaning J.P.Morgan Chase $30 b. to purchase it at a fire sale price of $236 million on Sunday after Bear Stearns stock closed with a market valuation of $3.5 b. on Friday, March 14th.

The transaction raises a lot of questions. The ones I would like to deal with are: Why didn't the Fed just let Bear Stearns go bankrupt? How big a windfall was this for J.P.Morgan Chase? What risks does this Fed action pose for the future?

We don't know why the Fed took this action. Their press release announced the action in one sentence without any explanation.

We are left to conclude that the Fed viewed the bankruptcy of Bear Stearns, which specialized in mortgage finance, as a financial market calamity, the costs of which would exceed putting $30 b. of taxpayer money at risk and the future risk if other firms follow Bear Stearns' example.

All I can say is there must be a lot of red ink hidden in the Bear Stearns deal and a lot of potential collateral damage to justify the Fed's action. Fed Chair Ben Bernanke and Treasury Secretary Hank Paulson are rational and experienced people. I'm sure they did the math and fully considered the "moral hazard" of what this action might cost future taxpayers. Bernanke is an expert in financial market panics, and his research has taught him that only prompt and strong action can avert them.

Nonetheless, J.P.Morgan Chase appears to have hit the lottery. It's market capitalization rose 26%, or $32.1 b., between, it's close at $36.54 per share ($124.1 b. market capitalization) on March 14th and it's close on Thursday, March 20th at $45.97 per share ($156.2 b.). There are a lot of former Bear Stearns shareholders and employees who feel cheated out of their chance to do better in bankruptcy court.

We have no way of knowing what risks the Fed's Bear Stearns bailout will create for U.S. taxpayers, and it won't be possible to estimate them years from now either because we'll never see the world as if the Fed hadn't bailed out Bear Stearns. All we'll observe is whether the Fed gets our $30 b. loan back and whether any more of our money is committed beyond that.

Think of it this way: If you're the CEO of another investment bank that's "too big to fail," and you had taken on too much risk in pursuit of profits that have suddenly evaporated in the mortgage crisis, what would you do? Would you shed risk, try to recapitalize, hunker down as best you can, and own up to big losses, or would you take on even more risk in hope going "double or nothing" would pay off, knowing that the Fed would intervene if "nothing" is the outcome?

Economists used to believe that people were strictly rational, but recent research has proven that we're not. Faced with very unpalatable choices, we often act irrationally and make bad situations worse. We know some CEOs have acted badly in the past.

Today is Easter. Let's pray that Ben Bernanke and Hank Paulson, when facing very difficult choices involving huge financial risks, can steer us clear of this crisis.