WASHINGTON -- Bear Stearns could not be allowed to collapse because it could have shattered confidence in financial markets and caused lasting damage to the economy, top regulators said on Thursday in defending the rescue of what was once the fifth-largest U.S. investment bank.
At a U.S. Senate Banking Committee hearing on the bank's downfall last month, senior federal officials, including Federal Reserve Chairman Ben Bernanke, rejected the notion that they had in effect bailed out Bear. The Fed committed $29 billion in taxpayer money to back assets as part of an agreement for JPMorgan Chase & Co to buy the stricken investment bank.
Bear's rescue, orchestrated by the U.S. central bank in close consultation with the Treasury Department, prompted tough questions from members of Congress over whether regulators had set a dangerous precedent by risking public funds to salvage a bank that had made risky investment decisions.
"Was this a justified rescue to prevent a systemic collapse of financial markets or a $30 billion taxpayer bailout, as some have called it, for a Wall Street firm while people on Main Street struggle to pay their mortgages?" asked Sen. Christopher Dodd, the Connecticut Democrat who chairs the committee.
"What we had in mind here was the protection of the American financial system and the protection of the American economy," Bernanke said. "I believe that if the American people understand that we were trying to protect the economy and not to protect anybody on Wall Street, they would better appreciate why we took the action we did."
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The credit crisis that has gripped U.S. markets has also roiled overseas markets and forced regulators and central banks to stave off a global market seizure by injecting capital.
Alabama Sen. Richard Shelby, the panel's top Republican, said the Fed needed to be wary of inadvertently rewarding risky behavior.
"I think we must guard against creating a moral hazard that encourages firms to take excessive risk based on the expectations that they will reap all the profits while the federal government stands ready to cover any losses if they fail," he said.
COULD NOT SEE IT COMING
The hearing comes as lawmakers grapple with how to modernize a patchwork of banking regulations, many of which date back to the Great Depression or earlier. Critics contend that poor regulatory oversight was at least partly to blame for the subprime mortgage mess that quickly exploded into a global financial crisis.
Christopher Cox, chairman of the Securities and Exchange Commission, said his agency could not have foreseen Bear's sudden cash crisis. "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" of large global banks, he said.
Cox has said, however, that bank guidelines may need to be tightened.
Bernanke said on Wednesday that Bear had notified the Fed and other regulators on March 13 that it would have to file for bankruptcy the next day unless it could secure financing. He repeated on Thursday that the Fed thought it must act immediately or risk serious damage not only to global financial markets, but also the broader economy.
On March 14, the Fed and JPMorgan announced emergency financing. Two days later, JPMorgan agreed to buy Bear for just $2 per share -- well below the $60 where it had traded the previous week. The offer has since been raised to $10 a share.
Treasury Undersecretary Robert Steel echoed Bernanke's comments, noting that the government's focus was "not on this specific institution, but on the more strategic concern of the implications of a bankruptcy.
"The failure of a firm that was connected to so many corners of our markets would have caused financial disruptions beyond Wall Street," he said.
Jamie Dimon, JPMorgan's chief executive, said his firm would not have agreed to buy Bear without the Fed's financial backing, and insisted that JPMorgan did not "cherry pick" the best Bear assets. Under its deal with the Fed, JPMorgan will have to incur the first $1 billion in any losses should Bear's assets deteriorate further.
Cox said his agency had never contemplated a situation in which a bank — in this case Bear — would not be able to obtain loans despite having strong collateral.
No SEC models take into account "the possibility that secured funding, even that backed by high-quality collateral such as U.S. Treasury and agency securities, could become unavailable," he said.
Earlier this week, Treasury Secretary Henry Paulson unveiled recommendations to streamline regulation of the U.S. financial sector, including combining some agencies and changing the scope of the Fed's oversight.
The plan was met with skepticism on Capitol Hill and from many of the various agencies whose roles would be curtailed under the proposals. It is unlikely to be implemented any time soon.
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