FORUM: The Fed's actions

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Last month, the Federal Reserve took unprecedented action and opened the discount window to investment banks. At the same time, they potentially exposed American taxpayers to billions of dollars of loss by guaranteeing the value of a variety of Bear Stearns' hard-to-sell assets.

Many concerns have been raised about the Fed's facilitation of J.P. Morgan Chase's bid to purchase the failing investment bank for pennies on the dollar and their subsequent approval of the financing arrangement of the deal. An even larger issue we must now consider is how the Fed's extension of credit to investment banks may promote risky investment behaviors, strengthen the expectation of government assistance and encourage politicians to overreact by imposing new regulations.

Taxpayers across America are rightly concerned with what might happen if another giant falls. Will they be treated the same way as Bear Stearns thereby exposing taxpayers to even more financial risk in the name of promoting economic stability? A dangerous precedent has been set by the Federal Reserve and the Congress must do everything we can to prevent other market players from automatically assuming the Fed will rescue them. The Fed should not step in to preserve shareholder and bondholder value in the guise of preventing the failure of counterparty obligations. Each investor who chooses to invest does so with the understanding that the rewards are directly tied to the risk taken.

I am also concerned about the calls for increased regulation. When I heard of the Fed's decisions, I first thought it would lead to immediate calls for increases in regulatory oversight and revamping of our financial regulatory scheme. Unfortunately, that is exactly what has happened. Less than one week after the Fed's action, Barney Frank, chairman of the Financial Services Committee, rolled out a variety of new proposals calling for the creation of a new Financial Services Systemic Risk Regulator and a plan to bailout troubled mortgage holders.

Another new regulatory blueprint was announced yesterday by Treasury Secretary Hank Paulson to completely overhaul the financial regulatory system. His proposals to increase the authority of the Federal Reserve, merge the Securities and Exchange Commission and Commodity Futures Exchange Commission and create an Optional Federal Insurance charter are very broad in their scope and potential impact. It is important to carefully consider this proposal because we must ensure our regulatory scheme promotes a transparent and well-functioning financial services sector. Congress must also ensure that U.S. regulated companies are operating on an even playing field with their international competitors. We do not want to erect new barriers that harm our nation's role as a leader in the world's capital markets.

It should be noted that most of Mr. Paulson's proposals have been in the works for more than a year and the proposals do not directly address the Fed's actions or the more immediate concerns of the subprime market. This encompassing proposal should also not be the sole focus of Congress' review. In fact, I think we must put it aside while we look first to the Fed's action to ensure that examination receives the attention it deserves.

It is clear that Congress, the administration and our regulatory bodies should be concerned about what is happening in the economy and the housing markets. However, we must seek a careful balance to ensure we do not solve one problem today while creating a much larger problem to contend with later. It is important for our governmental agencies to work closely with the financial services industry to ensure the stability and liquidity of our nation's financial markets. It is also critical the Congress and Federal Reserve are cautious about encouraging further risky behavior by inappropriately using government tools to prevent the free market from responding to changing market conditions.

Unfortunately, the Fed's actions could provide Chairman Frank and the Democrats with the necessary momentum to pass. When Congress feels compelled to act in an expedited manner due to a perceived emergency, it usually sets in motion a worrisome chain of events that leads to an outcome that is far worse. One only needs to look at the passage of Sarbanes-Oxley in the wake of the Enron crisis to see an example of bad legislation that was hastily enacted without the proper vetting and review.

Congress and American taxpayers must not accept the Fed's actions as a fait accompli. Before Congress races to impose new regulations or change the regulatory structure, it is imperative the Congress conduct a vigorous debate on the merits of the Fed's intervention. As a Member of the Financial Services Committee, I look forward to the opportunity to directly question Fed Chairman Ben Bernanke and Mr. Paulson about the actions leading up to Federal Reserve's decision to act.

Rep. Scott Garrett, New Jersey Republican, is a member of the House Financial Services Committee.