April 2 (Bloomberg) -- When the Federal Reserve brokered a weekend deal last month for JPMorgan Chase & Co. to purchase Bear Stearns Cos. before it collapsed, many of the terms of the agreement were murky.

The Fed made it clear it had to cough up $30 billion ($29 billion on the second go-round) for Bear Stearns's ``less liquid assets'' to induce JPMorgan Chief Executive Jamie Dimon to sign off on the deal. What was unclear was the Fed's relationship to those assets.

At the time, the Fed said it was taking control of the $30 billion portfolio, that it wasn't purchasing the assets. The Fed was assuming the risk if the eventual liquidation of the securities produced further losses -- losses that accrue to the taxpayer since the Fed turns over its profits to the U.S. Treasury. It also stood to benefit if the portfolio appreciated in value.

That doesn't pass the lender duck test. Lenders don't profit from the appreciation of an asset against which they extend credit. Only an equity owner does.

``They get the residual -- that almost always defines ownership,'' said Paul DeRosa, a partner at Mt. Lucas Management Co. ``The disclaimer of ownership is purely semantic.''

If the Fed is the residual owner of these securities, which seems likely based on its assumption of both risk and reward, it could be in violation of its charter. According to the 1913 Federal Reserve Act, which has been amended over the years, the Fed can buy U.S. Treasury and agency securities, foreign government securities, bankers acceptances, bills of exchange, certain municipal debt, foreign currency and gold.

Ownership Society

Nothing in there about collateralized debt obligations, private mortgage-backed securities or other derivatives of questionable quality.

Of course, if the Fed structured its loan as a ``discount'' -- the Fed is authorized to discount drafts, notes and bills of exchange, redeeming them at maturity -- then it would be a lender and a residual owner, said Vince Reinhart, former director of the Fed's Monetary Affairs Division and now a scholar at the American Enterprise Institute in Washington.

Most of today's loans from the Fed are ``advances,'' secured by ``acceptable collateral'' (the level of acceptability keeps declining). The collateral is returned to the borrower after a specified time.

If it seems like a distinction without a difference, it is.

``From an economic perspective, they are the residual claimant,'' Reinhart said. ``They have equity ownership.''

In the spirit of increased transparency, why can't the Fed come out and say that?

Fact(less) Sheet

On March 24, the New York Fed posted a summary of the terms and conditions of the loan on its Web site. In essence, the Fed created an off-balance sheet vehicle -- specifically a Delaware limited liability company -- to hold illiquid securities, and with no capital, funded by a $29 billion loan from the Fed and a subordinated $1 billion loan from JPMorgan, Reinhart said.

The Fed is nothing if not a quick study.

BlackRock Inc. has been retained as the manager.

The summary outlined the maturity of the loan (10 years, renewable at the discretion of the New York Fed); the interest rate on the loan (the primary credit rate, currently 2.5 percent, on the Fed loan; the primary credit rate plus 4.5 percent for JPMorgan); and the repayment terms. It skirted the ownership issue other than to say in the last line that ``any remaining funds resulting from the liquidation of the assets will be paid to the New York Fed.''

Legal Cover

Watching the evolution of Fed policy in the last six months from focused on inflation to fearful of systemic risk; the series of aggressive, rapid-fire rate cuts; the creation of an alphabet soup of new lending facilities; and the orchestration of a fire sale of Bear Stearns to JPMorgan, one has to wonder about the Fed's M.O. It all has a make-it-up-as-you-go-along quality.

Faced with what it thought would be a series of cascading financial failures if Bear Stearns went down, the Fed probably knew what it wanted to do, knew it had to do it quickly, and then had to figure out ``how to get it done within the confines of its legal structure,'' DeRosa said. ``The Fed used legal sleight of hand to reconcile what they wanted to do with what they're permitted to do by law.''

Bernanke is sure to be grilled about his actions when he testifies before the Joint Economic Committee of Congress today and the Senate Banking Committee tomorrow. A wee bit more transparency would be nice.

Then again, if the Fed is acting first and finding legal cover later, there's a benefit to keeping the details murky.

(Caroline Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Caroline Baum in New York at cabaum@bloomberg.net.

Last Updated: April 2, 2008 00:01 EDT