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MARCH TO AUGUST : SYSTEMIC RISK CONCERNS                       


         from  to , Merrill Lynch’s fell from  to , Morgan Stanley’s fell from
                                                
          to , and Goldman’s fell from  to . Another measure of risk was the
         haircuts on repo loans—that is, the amount of excess collateral that lenders de-
         manded for a given loan. Fed officials kept tabs on the haircuts demanded of invest-
         ment banks, hedge funds, and other repo borrowers. As Fed analysts later noted,
         “With lenders worrying that they could lose money on the securities they held as col-
         lateral, haircuts increased—doubling for some agency mortgage securities and in-
         creasing significantly even for borrowers with high credit ratings and on relatively
         safe collateral such as Treasury securities.” 
            On the day of Bear’s demise, in an effort to get a better understanding of the in-
         vestment banks, the New York Fed and the SEC sent teams to work on-site at
         Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley. According to
         Erik Sirri, director of the SEC’s Division of Trading and Markets, the initial rounds of
         meetings covered the quality of assets, funding, and capital. 
            Fed Chairman Ben Bernanke would testify before a House committee that the
         Fed’s primary role at the investment banks in  was not as a regulator but as a
                                                    
         lender through the new emergency lending facilities. Two questions guided the
         Fed’s analyses: First, was each investment bank liquid—did it have access to the cash
         needed to meet its commitments? Second, was it solvent—was its net equity (the
         value of assets minus the value of liabilities) sufficient to cover probable losses? 
            The U.S. Treasury also dispatched so-called SWAT teams to the investment banks
         in the spring of . The arrival of officials from the Treasury and the Fed created a
         full-time on-site presence—something the SEC had never had. Historically, the SEC’s
         primary concern with the investment banks had been liquidity risk, because these
         firms were entirely dependent on the credit markets for funding. The SEC already
                                                            
         required these firms to implement so-called liquidity models, designed to ensure that
         they had sufficient cash available to sustain themselves on a stand-alone basis for a
         minimum of one year without access to unsecured funding and without having to
         sell a substantial amount of assets. Before the run on Bear in the repo market, the
         SEC’s liquidity stress scenarios—also known as stress tests—had not taken account of
         the possibility that a firm would lose access to secured funding. According to the
         SEC’s Sirri, the SEC never thought that a situation would arise where an investment
         bank couldn’t enter into a repo transaction backed by high-quality collateral includ-
         ing Treasuries. He told the FCIC that as the financial crisis worsened, the SEC began
         to see liquidity and funding risks as the most critical for the investment banks, and
         the SEC encouraged a reduction in reliance on unsecured commercial paper and an
         extension of the maturities of repo loans. 
            The Fed and the SEC collaborated in developing two new stress tests to determine
         the investment banks’ ability to withstand a potential run or a systemwide disruption
         in the repo market. The stress scenarios, called “Bear Stearns” and “Bear Stearns
         Light,” were developed jointly with the remaining investment banks. In May,
         Lehman, for example, would be  billion short of cash in the more stringent Bear
         Stearns scenario and  billion short under Bear Stearns Light. 
            The Fed conducted another liquidity stress analysis in June. While each firm ran
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