Regulators and bankers defend Bear Stearns rescue

By Patrick Rucker and Karey Wutkowski

WASHINGTON (Reuters) - 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 congressional hearing on the bank's downfall, senior federal officials, including Federal Reserve Chairman Ben Bernanke, rejected the notion that they had in effect bailed out Bear last month. The Fed committed $29 billion in taxpayer money to back Bear's assets to facilitate JPMorgan Chase & Co's agreement to buy the stricken investment bank.

Bear's chief executive, Alan Schwartz, said without that deal, his firm would have filed for bankruptcy last month. That would have been far more costly to the U.S. economy because it would have led to higher borrowing costs for everything from mortgages to municipal loans, JPMorgan CEO Jamie Dimon said.

"Bear Stearns would have failed without this effort, and the consequences would have been disastrous," Dimon told the Senate Banking Committee. "The idea that the Bear Stearns fallout would have been limited to a few Wall Street firms just isn't so."

Dimon said his firm would not have agreed to take over Bear without the Fed's financial backing, and said that JPMorgan had also agreed to guarantee $25 billion that Bear had borrowed from the central bank.

Bear's rescue, orchestrated by the Fed 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."

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 of the 1930's 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 those bank guidelines may need to be tightened.

Bernanke said the Fed thought it needed to act immediately on Bear or risk serious damage not only to global financial markets, but also the broader economy.