Federal Reserve Chairman Ben S. Bernanke said Tuesday regulators should be empowered to close down investment banks like Bear Stearns that are deemed "too big to fail," but with action by Congress unlikely this year, the Fed may have to keep providing emergency loans to Wall Street to forestall any more spectacular failures.
In a speech addressing curing the causes of the housing and mortgage crisis, Mr. Bernanke also said the Fed should have more power to regulate Wall Street firms and the complex financial products that they create, like the estimated $250 billion of credit swaps and derivatives that the Fed was forced to help guarantee in its rescue of Bear Stearns in March.
To address the serious deterioration of lending standards that contributed to the crisis, he said the Fed will give its final blessing next week to rules banning so-called "liar loans" and other loose lending practices in the future.
"Recent experience has illustrated once again that financial instability can have serious economic costs," he said at a forum sponsored by the Federal Deposit Insurance Corp. (FDIC), noting that the credit crisis that broke out nearly a year ago has been the underlying cause of the U.S. economy's weakness ever since.
Revisions to banking laws going back as far as 1913 are needed to ensure the Fed and other regulators are better prepared to prevent and address future crises, he said.
Jamie Dimon, chief executive of JP Morgan Chase & Co., which acquired Bear Stearns at the Fed's behest and took on most of the firm's extensive liabilities, said the financial markets would have faced a "catastrophe" had the Fed not engineered the extraordinary rescue.
But he too called on Congress to pass procedures that will enable regulators to close down Wall Street firms when they fail in the future, the same way the FDIC closes and liquidates insolvent banks today.
Their comments came as another major mortgage lender, IndyMac Bank, announced it was stopping its lending business and was experiencing "elevated levels" of withdrawals.
The beginning of a possible run on the bank's deposits prompted FDIC Chairman Sheila Bair to say that she does not expect consumers to be hurt by what is expected to be a rash of bank failures this year.
"People should not worry," she told Bloomberg Television. "Nobody's ever lost a penny of insured deposits."
Ms. Bair was the first one to call for new powers to close investment banks this year. Treasury Secretary Henry M. Paulson Jr. recently joined in the chorus, saying such new authorities will be critical to maintaining stability and preventing bailouts in the future.
Closing down a large investment bank would be "complicated, but we're going to need that option," Mr. Dimon said. "No one should be too big to fail."
Top Wall Street firms and banks from Lehman Brothers to Citibank and Merrill Lynch have run into rumors of insolvency as they reported a seemingly endless string of credit losses totaling about $400 billion this year.
The investment banks have been borrowing heavily from the Fed's discount window since March, and analysts say that may have prevented one or two of them from collapsing in Bear Stearns' footsteps.
Mr. Bernanke said he may need to keep that window open until 2009, when he hopes the financial crisis will have subsided and a new president and Congress are installed.
Mr. Dimon questioned whether the Bear Stearns bailout will cost taxpayers anything, contending that his own century-old bank took on most of the company's $250 billion in contractual credit obligations.
The Fed provided $29 billion in financing for the takeover, and acquired in return some of Bear Stearns' questionable mortgage assets, which it must resell in the next 10 years to prevent a loss for taxpayers.
The JP Morgan executive contended that banks are bearing the brunt of the crisis and it is homeowners - a estimated quarter to a third of whom he said lied about their incomes or other matters to get loans during the housing bubble - who have gotten off easy.
"American consumers did OK," he said, with many making money off the housing boom while many of those who lost money are now turning over the keys and letting the banks and investors who purchased their mortgages suffer the losses.
Banks and mortgage brokers have learned some hard lessons, and the credit losses are likely to get worse for many, he said. The most important change that resulted from the crisis was banks going back to their traditional standards requiring at least a 20 percent down payment on mortgage loans.
"There's a reason" banks required down payments for many decades before the latest housing boom, he said. "We learned that the hard way. We need to write a letter to the next generation" to make sure they don't make the same mistake, he said.
Mr. Paulson told the forum that many of the expected 2.5 million foreclosures this year are unavoidable because people bought houses they couldn't afford.
"There is little public policy-makers can - or should - do to compensate for untenable financial decisions," he said.
The Federal Housing Administration announced an expansion of its Hope Now program for homeowners facing foreclosure that it estimated will enable 100,000 people to stay in their homes through refinancings.
Currently, most mortgages are required to meet standards laid down by Fannie Mae and Freddie Mac, which have been purchasing nearly three-quarters of mortgages made this year.
Regulators said yesterday they would work to ensure that the two mortgage giants are able to keep propping up the housing market, possibly giving them an exemption from strict new accounting rules, which would require them to restrict lending and build up capital.