Regulators say Bear collapse showed weaknesses

WASHINGTON (Reuters) - The collapse and forced sale of Wall Street giant Bear Stearns exposed the dangerous interconnection of financial markets and the faulty oversight now in place, U.S. regulators said on Thursday in prepared testimony to Congress.

Bear's collapse last month evolved in a matter of days, even though the firm had more than enough capital to meet existing tests of soundness, regulators were expected to tell the Senate Banking Committee in a hearing which opened on Thursday to explore the bank's rescue.

The investment bank's rescue, orchestrated by the U.S. Federal Reserve in close consultation with the Treasury Department, sparked heated debate over whether the government had improperly risked taxpayer money to salvage a Wall Street firm. The central bank agreed to provide $29 billion in government money to back Bear assets.

Regulators were expected to face tough questioning from members of Congress over whether they had set a dangerous precedent by coming to the aid of a bank that had made risky investment decisions.

"Up to and including the time of its agreement to be acquired by JP Morgan Chase, Bear Stearns had a capital cushion well above what is required to meet the Basel standards," Securities and Exchange Commission Chairman Christopher Cox said in prepared remarks.

The Basel capital framework sets reserve standards for the world's largest banks and Cox has said those guidelines may need to be tightened.

Despite those strong capital reserves, regulators said they worked together to facilitate a JP Morgan Chase buyout of Bear Stearns to save financial markets from turmoil.

Fed Chairman Ben 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 week before. The offer has since been raised to $10 a share.

Robert Steel, Treasury Undersecretary for Domestic Finance, 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 added in his speech on Thursday.

SEC's Cox said his agency had never contemplated a situation, which Bear faced, of not being able to obtain loans with 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," Cox said in the prepared remarks.

The hearing comes as lawmakers grapple with how to modernize the patchwork of banking regulations, many of which date back to the Great Depression or even 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.

Earlier this week, Treasury Secretary Henry Paulson unveiled recommendations to streamline regulation, including combining some agencies and changing the scope of the Fed.

The plan was met with skepticism on Capitol Hill and from many of the various agencies that would see their roles curtailed under the proposals. It is unlikely to be implemented any time soon.

(Additional reporting by Mark Felsenthal in Washington and Pedro Nicolaci da Costa in New York; Writing by Emily Kaiser, Editing by Walker Simon)