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Boston Fed president says current broker-dealer rules won’t prevent another Bear Ster
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Boston Fed president says current broker-dealer rules won’t prevent another Bear Ster

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Boston Fed president says current broker-dealer rules won’t prevent another Bear Ster

Broker-dealers need to reduce risk and increase capital if they don’t want to end up like Bear Stearns or Lehman Brothers, said Eric Rosengren, the president of the Boston Federal Reserve.

The outspoken regulator blasted the Securities and Exchange Commission, the industry’s main regulator, for not doing enough.

“Given the widespread support provided to broker-dealers and the difficulties they encountered during the crisis, a comprehensive re-evaluation of broker-dealer regulation is overdue,” said Rosengren in a speech on Wednesday.

Broker-dealers are at the heart of the securities and derivatives trading process and play an important role in providing liquidity to the market and facilitating trading activities for customers.

This is not the first time the Fed has criticized the SEC. The two are currently fighting over governing rules for money market funds, said industry observers.

“During the financial crisis, deteriorating confidence in broker-dealers was compounded by the fact that investors were also fleeing money market mutual funds,” said Rosengren.

The SEC recently approved rules for money market funds which will prevent a run on the funds during stress in the economy and certain funds will have a floating net asset value, instead of $1 a share, to remind investors that the funds are not without risk.

To prevent a run on a fund or reduce risk, broker-dealers need to hold “significantly more capital,” suggests Rosengren.

“What is striking is the lack of change – while there has been some improvement in capital, the 2013 liability structure looks surprisingly similar to the structure that prevailed before the financial crisis,” he said.

High leverage scares the Federal Reserve, says Coffee.

“In the years just before 2008 there was a significant leverage build-up of broker dealers and they don’t want that to happen again,” said Coffee.

Being over-leveraged for a broker-dealer means the business is carrying too much debt and is unable to pay expenses.

The Fed’s concern is that the death of one broker-dealer could have a domino on others, notes Coffee.

During the financial crisis, Bear Stearns and Lehman Brothers collapsed due to over-leverage.

Bear Sterns failed in 2008 after it was leveraged 35 to 1 from over exposure to failing mortgage-backed securities. Despite an emergency loan from the Federal Reserve, the brokerage firm collapsed and was later sold to J.P. Morgan Chase & Co. JPM for far below its 52-week high of $133.20 a share.

Lehman Brothers became bankrupt in 2008 after it had large positions in subprime-mortgage securities and investor confidence caused a run on the bank.

The rules to govern broker-dealers under the SEC have not been updated for 40 years, and since the financial crisis, there are new consideration to keep in mind, says Coffee.

“I do think the that SEC’s net capital rules were never drafted with systemic risk in mind,” said Coffee.

Boston Fed president says current broker-dealer rules won?t prevent another Bear Sterns - The Tell - MarketWatch

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