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Here are the words that seem to have wiped 200 points off the Dow Jones late on Wednesday, sent credit spreads wider and generally got everyone thinking that this Credit Crunch thingy might not be in the past after all.

They were uttered by the SEC’s director of trading and markets, Erik Sirri, in testimony to the congressional subcommittee examining regulation of investment banks:

I will now turn to steps the SEC has taken and additional protections that are being contemplated by CSEs [consolidated supervised entities]in the wake of Bear Stearns. In addition to strengthening the liquidity requirements for CSE firms relative to their unsecured funding needs, we are closely scrutinizing the secured funding activities of each CSE firm, with a view to lengthening the average term of secured and unsecured funding arrangements. We are currently obtaining funding and liquidity information for all CSEs on a daily basis, and discussing with CSEs the amount of excess secured funding capacity for less-liquid positions. Further, we are in the process of establishing additional scenarios, focused on shorter duration but more extreme events that entail a substantial loss of secured funding, that will be layered on top of the existing scenarios as a basis for sizing liquidity pool requirements. This additional analysis is providing the basis for requiring firms to take steps such as increasing the term of secured funding and diversity of funding sources. Also, we are discussing with CSE senior management their longer-term funding plans, including plans for raising new capital by accessing the equity and long-term debt markets.

Because the CSEs now have temporary access to the Primary Dealer’s Credit Facility (”PDCF”), which would operate as a back-stop liquidity provider should circumstances require, and assures the necessary breathing space to implement the various measures outlined above, the SEC is in frequent discussions with the Federal Reserve Bank of New York both about the financial and liquidity positions of the CSEs, and issues related to the use and potential use of the PDCF. The SEC and the Federal Reserve Board are developing a formal Memorandum of Understanding that would provide an agreed-upon scope and mechanism for information sharing, both related to the PDCF and other areas of overlapping supervisory interest. Moreover, should Congress enact legislation to provide access to an external liquidity provider under exigent conditions in the future, the SEC stands ready to develop a process by which the Commission would formally communicate with the Federal Reserve or other relevant agencies in the event that an institution required access to any successor facility. Finally, the Chairman has publicly requested dedicated funding for the CSE program, and a significant expansion in staff.

Conclusion

The CSE program adopted by the Commission has served to fill a serious gap left after the Gramm-Leach-Bliley Act broadly restructured the regulation of financial institutions. Although supervised on a elective basis by the Commission under the CSE program, and in compliance with applicable capital standards at the holding company and regulated entity level, Bear Stearns ultimately was overwhelmed by the unprecedented demands for liquidity it faced in a crisis of confidence. The CSE program ensured that, despite this unprecedented occurrence, the funds and securities of customers of the broker-dealer were never imperiled, and remained protected both by the significant capital at the holding company level and the Commission’s financial responsibility requirements, including segregation of customer securities and funds, at the broker-dealer level. As a result, despite the run on the bank to which Bear Stearns was subjected, at no time during the week of March 10th, up to and including the date of the agreement with JPMorgan, were any of the customers of the Bear Stearns’ broker-dealers at risk of losing their cash or their securities.

The CSE oversight of Bear Stearns also provided a ready source of information for banking supervisors of the deteriorating condition of Bear Stearns as the crisis unfolded, enabling rapid and knowledgeable decision-making by the Federal Reserve.

Bear Stearns’ experience has challenged a number of assumptions, held by the SEC and by other regulators, relating to the supervision of large and complex securities firms. The SEC is working with other regulators to ensure that the proper lessons are derived from these experiences, and changes are made to the relevant regulatory processes to reflect those lessons. This work is occurring in a number of venues, including working groups operating under the auspices of IOSCO, the Basel Committee on Banking Supervision, and the Financial Stability Forum. For example, we are working in the Basel Committee to implement Chairman Cox’s call for amended capital adequacy standards for internationally active sophisticated institutions to deal explicitly with liquidity risk.

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. 

We might ask, glibly: “What’s new?”

Clearly, some people forgot that a regulatory stick would follow Bear’s demise.

Related links:
Erik Sirri’s full testimony - SEC
HT - Marc Otswald, Monument Securities