Fed’s regulatory powers likely to be expanded

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One thing now seems certain to come out of Congress’ plodding financial reform effort: The Federal Reserve, after being castigated for much of the past year for overlooking major problems that led to the global financial crisis, will receive more power to try to prevent such crises in the future.

Both the House-passed reform bill and a measure being pushed by Senate banking committee Chairman Christopher J. Dodd would put the Fed in the driver’s seat — with varying degrees of advice and consultation with other regulators — for supervising the largest banks and financial firms such as American International Group Inc., whose risky practices led to the near collapse of the financial system. The Fed also would be charged with breaking up big firms as necessary to prevent crises, or moving to close them if they become insolvent.

The Fed’s upgraded status comes as a surprise to many observers, after legislators from both parties berated the central bank and threatened its chairman, Ben S. Bernanke, with congressional investigations and even an ouster.

Top lawmakers now appear to be pulling in their horns in an apparent acknowledgment that the Fed acted largely within its powers to try to prevent a broader financial crisis in late 2008. Congress may now have little choice but to entrust the central bank with an even more explicit role.

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“They were asleep at the switch” like most other bank regulators, and people in Congress “got irritated about that,” said Dan Seiver, a finance professor at San Diego State University. Moreover, the unprecedented $182 billion Fed bailout of insurance giant AIG was “ugly” and “could have been handled better, and a bunch of people in Congress are mad about that.”

But the Fed redeemed itself by acting swiftly and responsibly to save the economy from an even worse fate that would have resulted had the financial system been allowed to unravel without Fed intervention, Mr. Siever said, and apparently that view came to dominate the thinking of the banking committees.

Amid all the anger last year, “I don’t think the Fed got enough credit for preventing another Great Depression,” Mr. Siever said. “That’s very important” in evaluating the central bank’s overall response to the crisis.

Mr. Dodd, Connecticut Democrat, has been a scathing critic of the Fed at times, calling its supervisory performance “abysmal.” He originally proposed taking away all regulatory responsibilities so the Fed could focus on guiding the economy through monetary policy.

But Sen. Bob Corker, the Tennessee Republican who negotiated the Fed portions of the latest Senate bill with Mr. Dodd, cited the central bank’s success at preventing an even deeper recession in giving his vote of confidence to Mr. Bernanke earlier this year.

“While he probably hasn’t made all the right calls, I’m not aware of anyone involved in the financial crisis that has,” Mr. Corker said. Banking groups also have defended the Fed as the agency best positioned to handle financial emergencies and regulate with an eye to preventing them.

The bill sailed through the full Banking, Housing and Urban Affairs Committee on a party-line vote Monday afternoon after Republicans withdrew hundreds of planned amendments at the weekend, instead saying they would negotiate on the bill in preparation for a Senate floor vote.

There are many reasons, both historical and practical, why Congress might continue to vest the greatest financial powers in the Fed, even if those arguments were rarely voiced during the battles in Congress last year.

The Fed is the only federal agency that interacts each day with global financial markets, both through its open market window in New York, where it buys and sells various debt instruments to regulate the money supply and level of interest rates, and through its weekly purchases of Treasury securities for its own account and on behalf of other global central banks.

The Fed chairman also regularly attends meetings of the Group of 20 economic powers and Group of Seven industrialized powers, where key decisions are made about coordinating financial and economic policy among the countries and financial centers where major banks operate. Those international connections will be critical in helping the Fed discover and prevent market problems.

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