Congress and federal regulators should consider new legislation or rules, including those that would extend capital adequacy standards to cover liquidity risk, to prevent other large banks from suffering the fate of Bear, Stearns & Co., Securities and Exchange Commission chairman Christopher Cox and a top Federal Reserve official told Senate Banking Committee members yesterday.
Cox, speaking at a hearing on the Fed-facilitated acquisition of Bear Stearns by JPMorgan Chase & Co., said that up until the run on Bear Stearns during the second week of March, the bank was "well capitalized and apparently fully liquid."
Yet Bear Stearns suffered an "unprecedented ... crisis of confidence" that denied it both unsecured financing, or loans without any collateral, as well as short-term secured financing even when the collateral consisted of Treasury bonds and other securities that had a market value in excess of the funds it was seeking to borrow.
"What happened to Bear Stearns ... was unprecedented," Cox said. "Counterparties would not provide [it] securities lending and clearing services [and] prime borrowers moved their cash elsewhere."
Referring to so-called Basel standards, Cox said: "At all times during the week of March 10-17, up to and including the time of its agreement to be acquired by JPMorgan Chase, Bear Stearns had a capital cushion well above what is required."
The SEC monitors the financial and operations health of the five largest Wall Street firms, through its consolidated supervised entities program, but, unlike the Fed, cannot extend credit or liquidity to them.
Cox said the Bear Stearns experience "has challenged the measurement of liquidity in every regulatory approach, not only here in the United States but around the world." The SEC chairman said he strongly supports considering "whether the capital adequacy standards applicable to internationally active sophisticated institutions should be extended to deal explicitly with liquidity risk."
Meanwhile, Timothy Geithner, the president of the Federal Reserve Bank of New York, provided a list of five reforms Congress should consider as it addresses reforming the financial services industry.
First, he called for a "stronger set of shock absorbers, in terms of capital and liquidity" for commercial banks and a limited number of the largest institutional banks "with a stronger form of consolidated supervision over those institutions."
Geithner said Congress should "substantially simplify and consolidate the regulatory framework, to reduce the opportunity for regulatory arbitrage, not just in the mortgage market, but more broadly."
He also argued that Congress should "make the financial infrastructure more robust, particularly in the derivatives and repo markets, so that the system can better withstand the effects of default by a major participant."
In addition, Geithner called for the "redesign [of] the set of liquidity facilities that we maintain in normal times" that would lead to a "stronger set of incentives and requirements for the management of liquidity risk by financial institutions with access to central bank liquidity." He said Congress should make sure that the Fed has "the mix of authority and responsibility to respond with adequate speed and force to the prospects of systemic threats to financial stability."
The hearing comes after the Treasury Department on Monday unveiled a 218-page blueprint for streamlining and modernizing the financial regulatory system, a document that was criticized by many top Democratic lawmakers, including Senate Banking chairman Christopher Dodd, D-Conn., who said yesterday that he does not see Congress considering the proposal this year.
"Obviously nothing will happen this year, we all know that," he said during the hearing. There is a "long road ahead," Dodd said, noting that the committee will continue to investigate the Bear Stearns deal and current market turmoil.
At least one senator, Jim Bunning, R-Ky., was opposed to any further government intervention, and characterized the Fed-facilitated JPMorgan purchase of Bear Stearns as an act of "socialism" by federal regulators. He said that an unfettered free market should be allowed to work.
But Fed chairman Ben Bernanke defended the Fed action, arguing that had Bear Stearns been allowed to collapse, the company's failure could have cast doubt on the financial positions of its "thousands of counterparties and perhaps of companies with similar businesses."
"Given the exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain," he said. "Moreover and very importantly, the adverse effect of a default would not have been confined to the financial system, but would have been felt broadly in the economy through its effect on asset values and credit availability."
