VideoIn testimony Thursday, Securities and Exchange Commission Chairman Christopher Cox said there is no way to know for certain whether or not the Federal Reserve's rescue of Bear Stearns was the right move, but said Congress should act to improve oversight of investment bank liquidity.
Testifying Thursday morning before the Senate Committee on Banking, Housing, and Urban Affairs, Cox said that the SEC's responsibility for regulating investment banks focuses primarily on ensuring that those firms can survive for at least a year without unsecured funding. "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," Cox testified, "Bear Stearns had a capital cushion well above what is required."
However, Cox added, neither the SEC's regulatory model, "nor any existing regulatory model has taken into account is the possibility that secured funding, even that backed by high-quality collateral such as U.S. Treasury and agency securities, could become unavailable." What happened to Bear Stearns, Cox told the committee, "has challenged the measurement of liquidity in every regulatory approach, not only here in the United States but around the world."
Cox said it was not possible to know for certain what would have happened had not JPMorgan agreed to acquire Bear before the markets opened on March 17. Unlike a laboratory experiment, he said, "in the social science of the market the selection of one course of action forever forecloses all other approaches that might have been taken."
But, Cox said, the experience made it clear that Congress should create a framework for coping with liquidity problems in investment banks, just as it has for commercial banks in the form of the Federal Deposit Insurance Improvement Act. Commercial bank protections, he said, reflect "that it is best not to improvise the principles which will guide federal intervention in financial institutions. That is a principle that I believe is equally valid not only with respect to depositary institutions, but other systemically important financial institutions as well."
The full text of Cox's prepared remarks appears below:
Thank you for inviting me to testify on behalf of the Securities and Exchange Commission about recent events in the financial markets and the implications of the merger agreement between JPMorgan Chase & Co. and The Bear Stearns Companies, Inc. The recent actions by the Federal Reserve, as Chairman Bernanke has described, are unprecedented and of unquestioned significance. They include not only the extension of guarantees and credit in connection with JPMorgan’s acquisition of Bear Stearns, but also the opening of the discount window to every one of the major investment banks.
What happened to Bear Stearns during the week of March 10th was likewise unprecedented. For the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured financing, but short-term secured financing, even when the collateral consisted of agency securities with a market value in excess of the funds to be borrowed.
Counterparties would not provide securities lending services and clearing services. Prime brokerage clients moved their cash balances elsewhere. These decisions by counterparties, clients, and lenders to no longer transact with Bear Stearns in turn influenced other counterparties, clients, and lenders to also reduce their exposure to Bear Stearns.
Over the weekend of March 15th and 16th, Bear Stearns faced a choice between filing for bankruptcy on Monday morning, or concluding an acquisition agreement with a larger partner. In the cauldron of these events, the actions that the Federal Reserve took – in particular, extending access to the discount window not only to Bear Stearns, but also to the major investment banks – were addressed to preventing future occurrences of the run-on-the-bank phenomenon that Bear endured.
It remains, however, for regulators and Congress to consider what other steps, if any, are necessary to harmonize this significant new safeguard with other aspects of the existing legislative scheme, and the regulatory structure that resulted from the enactment of the Gramm-Leach-Bliley Act.
The SEC, of course, does not have the function of extending credit or liquidity facilities to investment banks or to any regulated entity. Instead, through our consolidated supervised entities (CSE) program, the Commission exercises oversight of the financial and operational condition of Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley at both the holding company and regulated entity levels.
Our oversight of the CSEs includes monitoring for firm-wide financial and other risks that might threaten the regulated entities within the CSE, especially the U.S. regulated broker-dealer and their customers and other regulated entities, here and abroad.
In particular, the SEC requires that firms maintain an overall Basel capital ratio at the consolidated holding company level of not less than the Federal Reserve’s 10 percent "well-capitalized" standard for bank holding companies. CSEs provide monthly Basel capital computations to the SEC. The CSE rules also provide that an "early warning" notice must be filed with the SEC in the event that certain minimum thresholds, including the 10% capital ratio, are breached or are likely to be breached.
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