Treasury Secretary Henry Paulson released a blueprint that proposed the most sweeping overhaul of the nation's financial regulatory system since the stock market crash of 1929. It would change how the government regulates thousands of businesses, from the nation's biggest banks and investment houses to local insurance agents and mortgage brokers.
Paulson urged Congress to quickly give the Federal Reserve greater power to regulate the financial system.
His blueprint proposes giving the Fed more power to protect the stability of the entire financial system, but under the plan the central bank would lose its authority to oversee day-to-day bank supervision, which would be transferred to a single bank regulatory agency, merging the powers of five current federal bank regulatory agencies. Fed officials have said they must continue to have day-to-day supervision of commercial banks to monitor the banking system's health.
Paulson said any overhaul needed to be carefully balanced to make sure that expanded Fed powers to provide emergency support did not lead investment banks to pursue more risky strategies in a belief that the central bank would bail them out if they got in trouble.
Bush administration officials and independent regulators also propose prompt changes—either by giving more power to the Federal Reserve or the Securities and Exchange Commission, to meet the threat of a financial system breakdown.
Erik Sirri, director of the SEC's trading and markets division, said new legislation spelling out how, and by which regulators, big investment banks should be supervised is "an imperative from the Bear Stearns crisis."
Donald Kohn, vice chairman of the Federal Reserve, said the central bank is coordinating with the SEC to monitor large investment banks, which in general, "are strengthening liquidity and capital positions to better protect themselves against extreme events."
Their testimony before the Senate Banking subcommittee on securities suggested a subtle dance of differing views on regulation rather than an open turf battle.
Sirri noted that SEC Chairman Christopher Cox has called for an "explicit mandate" for the agency to supervise major investment banks at the level of their parent holding companies. Kohn said he wanted to make clear that the current system, in which the Fed is the primary overseer of banks' and financial firms' holding companies, "generally works well."
In light of the Bear Stearns debacle, the central bank's powers should be expanded, Paulson said in a speech to a women's business group in Washington. Policymakers must quickly consider how to give the Fed the authority it needs to protect the overall financial system, he said.
Since the stunningly swift decline and $29 billion government-backed rescue in mid-March of Bear Stearns, regulators, policymakers and legislators have been debating whether investment banks should come under tighter government controls. In some areas, such as limits on how much a financial institution can borrow relative to its capital, investment banks are less tightly regulated than commercial banks. The subcommittee's chairman, Sen. Jack Reed, D-R.I., said the issue of tightening regulation is part of a "dialogue that ultimately must lead to action."
Anxiety has been festering on Wall Street and among analysts that a full-fledged bank failure could occur if losses from mortgage-backed securities continue to mount. Estimates of damage from the mortgage market debacle have been rising, with the grimmest forecasts putting total losses as high as $945 billion.
While Congress appears unlikely to address the thorny issue of overhauling financial regulations this year, initial discussions are beginning. Lawmakers may consider a proposal that would empower regulators such as the SEC and the Fed to intervene—and possibly to shut down—investment banks that fail to meet federal requirements for minimum levels of capital held against risk.
The head of the Federal Deposit Insurance Corp. said the government must do a better job of contingency planning for the failure of a large investment bank. FDIC Chairman Sheila Bair said regulation of investment banks should more closely resemble that of commercial banks.
One possibility would be for the FDIC to take over and run a failing investment bank after the Fed or the SEC decided to shut it down, Bair said. The FDIC already does so for failed commercial banks.
