NEW YORK (CNNMoney.com) -- James "Jimmy" Cayne, former chief executive of Bear Stearns, testified Wednesday that the investment bank was brought down by "overwhelming" market turmoil, not risky bets in the mortgage market.
Cayne and four other former Bear Stearns executives testified before the Financial Crisis Inquiry Commission in a two-day hearing to investigate "the shadow banking system."
The commission also heard from two former Securities and Exchange Commission chairmen on the use of unregulated banking practices to artificially improve balance sheets. But the hearing covered a wide range of topics related to the proposed overhaul of the financial system currently being debated in Congress.
Cayne, who relinquished his post six months before Bear Stearns was hastily sold to JPMorgan Chase in early 2008, provided mostly terse responses to the commissioners' questions. Alan Schwartz, who was CEO in the brief period after Cayne's departure, did most of the talking.
Both executives argued that the downturn in the housing market, which precipitated the financial crisis, was virtually unpredictable. They also pointed out that the major ratings agencies had provided top-tier grades for many of the mortgage-backed securities that later sunk the firm.
When home values fell in 2007, the executives said investors were unable to assess how bad the potential losses could be for Bear Stearns and other investment banks. As a result, the credit markets seized up, and it was this lack of liquidity, they said, that ultimately undid Bear Stearns.
Cayne, who has been criticized for being out of touch during crucial moments in the crisis, said he was "shocked" that Bear Stearns failed. But he added that he was "happy" about the deal with JPMorgan, organized at the behest of the government, in which Bear Stearns went for about $2.2 billion, or $10 a share, in a fire sale.
"It was a marriage of convenience that was facilitated by the Fed," Cayne said. "The outcome was the best that could be expected when the world ended, for a lot of us."
In response to a question about whether Bear Stearns was over leveraged, or had insufficient capital to back its investments, Cayne acknowledged that leverage was too high, but said such practices were commonplace.
"That was the business, it was industry practice," he said. "In hindsight, I would say leverage was too high."
"OK, that was succinct," responded commission Chairman Phil Angelides.
Cayne also alluded to a speculative "conspiracy" based on "rumors" about potential losses at Bear Stearns that led to "a run on the bank" in March 2008. "The bottom line was, whether there was a conspiracy or not, the company came under attack," he said.
Brooksley Born, a commissioner who was chairman of the Commodity Futures Trading Commission, asked the executives about tactics banks use to alter the appearance of their balance sheets ahead of public statements, a practice known as window dressing.
"I don't agree with the word window dressing," Cayne said. "It denotes skullduggery, and we frown on that."
But both executives said the ability to shift some assets off balance sheet is appropriate under certain circumstances.
"I don't think, as some people might imply, that it was misleading," Schwartz said.
Christopher Cox, who was chairman of the SEC until early 2009, said in prepared remarks that the financial crisis, including the collapse of Bear Stearns, highlights the inadequacy of existing regulations.
"The financial crisis exposed weaknesses in regulated and unregulated areas, not least of all the so-called shadow banking system," he said.
The shadow banking system has grown "to a tremendous scale" in recent decades, he said, with 84% of all credit in the United States coming from "capital markets instruments" at the end of 2008.
He described the shadow banking system as the business of borrowing and lending money, or non-monetary equivalents, outside of the traditional banking system.
There are a range of institutions involved in shadow banking, including hedge funds, mutual funds and a growing number of commercial banks, he said.
But government-sponsored lenders, such as Fannie Mae and Freddie Mac, make up the largest component of the shadow banking system, according to Cox.
The former SEC chief, who has been criticized for lax oversight during his tenure, also called for greater transparency in the market for complex investments called derivatives, which many have blamed for exacerbating the financial crisis.
"Transparency is a powerful antidote for much of what occurred in the financial crisis, and this is nowhere more true than in the derivatives markets," said Cox.
William Donaldson, who preceded Cox as chairman of the SEC, defended his efforts to require broker-dealers such as Bear Stearns to disclose risks and scale back leverage under the agency's consolidated supervised entity program.
He said the program was a "significant, forward-looking effort to improve oversight," despite published reports suggesting the contrary. But he acknowledged that the program, along with other government efforts, were not sufficient in the recent financial crisis.
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