The Securities and Exchange Commission is strengthening its program to oversee holding companies with large and well-capitalized broker-dealers in the wake of the downfall of Bear, Stearns & Co. and would like Congress to legislatively authorize the program, which is currently carried out under rules, an SEC official told lawmakers yesterday.
"It's for you to decide" whether firms should be mandated to comply with the program, Erik Sirri, director of the SEC's trading and markets division, told a Senate Banking Committee panel. Currently the nation's four largest investment banks - Goldman, Sachs & Co., Lehman Brothers, Merrill Lynch & Co., and Morgan Stanley - only voluntarily participate in the program that was set up in 2004 and 2005, he said.
Bear Stearns also had been a participant in the so-called Consolidated Supervised Entities program before the rapid deterioration of liquidity at the investment bank during the week of March 10, which Sirri said was "unprecedented" and something the SEC "never anticipated."
"This was the first time, not only during the relatively brief existence of the voluntary CSE program, but at any time, that a major investment bank that was well-capitalized and fully liquid experienced a crisis of confidence that resulted in a loss not only of unsecured financing, but also short-term secured financing," Sirri said. "This occurred even though the collateral it was able to provide was high quality, such as agency securities, and had a market value that exceeded the amount to be borrowed."
As a result, the SEC is "strengthening the liquidity requirements for CSE firms relative to their unsecured funding needs" and is "closely scrutinizing the secured funding activities of each CSE firm, with a view to lengthening the average term of secured and unsecured funding arrangements," Sirri said.
"We are currently obtaining funding and liquidity information for all CSEs on a daily basis, and discussing with CSEs the amount of excess secured funding capacity for less-liquid positions," he said. "Further, we are in the process of establishing additional scenarios, focused on shorter duration but more extreme events that entail a substantial loss of secured funding, that will be layered on top of the existing scenarios as a basis for sizing liquidity pool requirements."
Sirri's comments came as SEC chairman Christopher Cox yesterday asked the Senate Appropriations Committee panel for dedicated funding and increased staff for both the CSE program and the commission's program to oversee the credit rating agencies, which also has been stepped up as a result of the Bear Stearns downfall. Sirri told lawyers Cox would like to expand staff in the CSE program to about 40 professionals from the current 25.
Sirri said the SEC has some "breathing space" to strengthen its CSE program because the big broker-dealer firms can temporarily borrow at a discount from the Federal Reserve Bank of New York's primary dealer's credit facility, which would serve as a back-stop liquidity provider should another crisis arise.
The SEC is discussing the financial and liquidity positions of the CSEs with the New York Fed and is drafting a memorandum of understanding that would outline the scope of and mechanism for information-sharing, according to Sirri.
But Sen. Chuck Schumer, D-N.Y., said the CSE program provides "weak regulation" because of the rapid changes in both technology and the markets. "We need to revamp our structure of financial regulation," he said. "We need a strong, a more unified regulator."
Former SEC chairmen Arthur Levitt and David Ruder, who also testified before the panel, said they would oppose consolidating the regulation of the financial markets under the Federal Reserve Bank or moving to principles-based regulation from enforcement and rule-based regulation of firms.
"I think its premature to choose any agency right now ... until we study exactly what went wrong," at Bear Stearns, said Levitt, who nevertheless added that he is intrigued with the idea of creating a new super-regulator.
"I would be very cautious in letting the Federal Reserve Bank oversee the entire banking and securities markets," Ruder said.
Both men said the SEC should remain independent of the White House and free from politicization. They also both said the commission should be given much more funding and that its enforcement division should be strengthened. Levitt said the SEC is issuing far lower penalties than ever before.