Financial Markets

Much criticism has been aimed at  Secretary of the Treasury Hank Paulson, Federal Reserve Chairman Ben Bernanke and SEC Chairman Christopher Cox for their swift action over the weekend of March 15-16 on Bear Stearns & Co. It is illuminating to read Cox’s letter to the Basel Committee on Banking Supervision(March 20, 2008) and the testimony of Erik Sirri, Director, Division of Trading and Markets, SEC to the Senate Sub-committe on Securities, Insurance and Investment (May 7, 2008) as it relates to this event and the changes that the SEC and global regulators(Basel Committee, IOSCO etc) are contemplating going forward regarding the regulation of investment banks.

Cox said:

As you will see, the conclusion to which these data point is that the fate of Bear Stearns was the result of a lack of confidence, not a lack of capital. When the tumult began last week, and at all times until its agreement to be acquired by JP Morgan Chase during the weekend, the firm had a capital cushion well above what is required to meet supervisory standards calculated using the Basel II standard.

Specifically, even at the time of its sale on Sunday, Bear Stearns’ capital, and its broker-dealers’ capital, exceeded supervisory standards. Counterparty withdrawals and credit denials, resulting in a loss of liquidity – not inadequate capital – caused Bear’s demise.

 Sirri testified:

Therefore, there is simply no provision in the law that requires investment bank holding companies to compute capital measures and maintain liquidity on a consolidated basis. Nor does the law provide for a consolidated supervisor that is knowledgeable in their core securities business, and that would be recognized for this purpose by international regulators.

Further, he said:

In essence, the entire CSE program was constructed around an alternative net capital regime at the broker-dealer, which carried as a condition the affiliated holding company’s consent to group-wide supervision by the Commission. This is a significant regulatory extrapolation that the Commission believed was necessary to fill a significant statutory gap.

 And

An imperative from the Bear Stearns crisis is addressing explicitly how and by whom large investment banks should be regulated and supervised, and specifically whether the Commission should be given an explicit mandate to perform this function at the holding company level, along with the authority to require compliance. We look forward to working with you on these broader questions.