By Yalman Onaran

April 2 (Bloomberg) -- The Federal Reserve was forced to rescue Bear Stearns Cos. last month because the securities firm faced bankruptcy and its failure could have led to a ``chaotic unwinding'' of investments throughout the U.S. economy, Fed Chairman Ben S. Bernanke said.

``The adverse effects would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability,'' Bernanke told the Joint Economic Committee of Congress at a hearing today in Washington.

The Fed agreed on March 14 to give emergency funding to New York-based Bear Stearns, formerly the fifth-largest U.S. securities firm, after a run on the company wiped out its cash reserves in two days. During the weekend following the rescue, Fed officials helped arrange a takeover by JPMorgan Chase & Co. at a fraction of Bear Stearns's market value.

Bernanke, who became chairman of the U.S. central bank in February 2006, said Bear Stearns advised the Fed and other government agencies on March 13 that it would have to seek Chapter 11 bankruptcy protection unless alternative sources of funds became available.

``With financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence,'' Bernanke said.

After striking a deal to buy Bear Stearns for less than 10 percent of its market value, JPMorgan increased its offer a week later amid a revolt by the smaller firm's shareholders. The new bid was still just a 3rd of Bear Stearns's stock price on March 14 and less than a 10th of its value in December.

Lawsuits Filed

A group of shareholders have asked a Delaware judge to halt the transaction while another group sued Bear Stearns executives for misleading them prior to the collapse.

The central bank has also agreed to provide $29 billion of financing to a separate entity that will buy the mortgage-related assets of Bear Stearns that are the hardest to sell.

``That was an extraordinary thing to do, I thought about it long and hard,'' Bernanke said, referring to the funding. ``I hope this is a rare event, I hope this is something we never have to do again.''

On March 16, when the JPMorgan deal was announced, the Fed simultaneously said it would start lending to brokers the way it provides funding to commercial banks, in order to prevent other bank runs. Since then, the agency has put examiners in those firms to monitor their financial health, Bernanke said.

The Securities and Exchange Commission, which regulates the investment-banking industry, didn't have an ``early warning'' on the Bear Stearns collapse, Bernanke said. The SEC has said the firm had sufficient capital until the last day.

``They may have had adequate regulatory capital, but their problem was liquidity,'' Bernanke said in his testimony.

Bear Stearns's financial troubles began in July, when two hedge funds that invested in securities tied to U.S. subprime mortgages collapsed. The firm had to bail out the funds and take possession of many of their holdings.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

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