Regulators: No Bear Stearns fallout

LONDON (CNNMoney.com) -- Financial markets have weathered the recent meltdown of two hedge funds at Bear Stearns but it's unclear what impact these sorts of blowups will have on the broader market when economic conditions shift, regulators told lawmakers Wednesday.

The impact of the implosion of the Bear Stearns funds appears to be "limited," Erik Sirri, director of the division of market regulation at the Securities and Exchange Commission, said.

Two hedge funds at Bear Stearns (Charts, Fortune 500) imploded after they made bad bets on securities backed by subprime mortgages. The meltdown has raised worries that subprime problems will pose a major risk to the broader market.

Federal Reserve Governor Kevin Warsh said problems in the subprime mortgage market were not leading to any "immediate systemic risk issues." But the pain from the subprime fallout is not over, he added.

Regulators testified at a House Financial Services Committee hearing - one of several on hedge funds and private equity firms, which have become dominant forces in the financial markets.

Recent meltdowns like the ones at Bear Stearns and the implosion of Amaranth last year have raised scrutiny of the rapidly growing hedge fund industry, whose assets under management have ballooned to $1.6 trillion, according to some estimates.

"I think we have an uneasy consensus that there is a potential problem here that we wish we were more sure about how to approach," said Rep. Barney Frank, the committee's chairman.

Hedge fund regulations have faced difficulty in the past. A Securities and Exchange Commission rule requiring hedge funds to register with the agency was struck down last year by a federal appeals court.

While hedge funds have proven a "challenge" to the regulatory system, "regulation shouldn't be a bad word," Frank said.

Warsh said hedge funds should strengthen their risk management practices and improve their market discipline. If they don't, "losses in the hedge fund sector could pose significant risks to financial stability," he said in prepared remarks.

While the House heard testimony on the risks posed by hedge funds, Senate tax writers were holding a hearing on to see if private equity and hedge fund managers are being adequately taxed.

But measures to raise taxes on fund managers - while worth debating - should be weighed carefully, Rep. Spencer Bachus said during the House hearing.

The benefits these private pools of capital bring to financial markets and U.S. competitiveness should not be overlooked, he said.

"The last thing we want to do is drive investment, whether it's hedge funds or private equity funds ... offshore," he said.