A Treasury proposal yesterday would grant the Federal Reserve new powers to supervise hedge funds, investment banks and other major financial players during emergencies, but critics say the real problem is the Fed’s unwillingness to use the broad regulatory authority it already has to prevent emergencies.
Despite several years of warning signs that loose mortgage lending had the potential to create a credit crisis, the Fed did not use its decades-old authority to bar risky lending practices nationwide until December — precisely when many economists think the economy started sinking into a recession led by the housing and mortgage crisis.
Some analysts also fault the Fed for not using regulatory tools to tackle the 2000 tech-stock bubble that led to the 2001 recession.
“The point is to regulate before the institutions get into crisis,” said Hunter College economics professor Howard Chernick, noting that the Treasury plan would reinforce the Fed’s own dubious practice of only taking action once a crisis emerges and there is no alternative.
The Fed two weeks ago arranged a hasty bailout of Bear, Stearns & Co. while giving 20 international investment firms access to its emergency lending window, even though it does not have authority to supervise those firms. The Treasury plan would give the Fed the power to collect information from the firms and regulate them — but only during emergencies.
Senate Banking, Housing and Urban Affairs Committee Chairman Christopher J. Dodd said the problem is not a lack of regulatory authority, but rather “the failure of this administration to utilize the tools they’ve been given over the years to deal with the very practices that caused this problem.”
The Connecticut Democrat, along with House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat, prodded the Fed last year into using its regulatory authority over mortgage lenders, warning the central bank to “use or lose” the powers Congress granted it.
Mr. Chernick said the Fed’s new powers under the Treasury plan would come too late to prevent recurring crises and recession, while doing little to protect taxpayers’ interests.
“New financial instruments in particular have to be evaluated for whether they are increasing leverage and systemic risk when they are introduced, not after the fact,” he said, referring to the universe of $50 trillion or more of complex mortgage- and credit-derivative securities whose dysfunction led to the current mortgage crisis.
“Off-balance-sheet funds in particular must be carefully monitored,” he said, noting that the Fed failed to question the widespread use of off-balance-sheet vehicles that enabled banks to take risks well beyond what banking regulators permitted.
Many of those off-budget “structured investment vehicles” collapsed and contributed to the profound financial problems banks now face.
Treasury Secretary Henry M. Paulson Jr., while conceding that additional emergency authority for the Fed are necessary in light of the Fed’s now-open lending window to Wall Street, continued to advocate a light-handed approach.
“The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability,” he said. “But it would be premature to assume these institutions should have permanent access to the Fed’s discount window and permanent supervision by the Fed.”
The cool reception from Mr. Dodd, Mr. Frank and other Democratic legislators suggests that the Treasury’s overhaul plan has little chance of action in Congress during Mr. Bush’s last year in office, even if legislators eventually agree to grant some enhanced authority to the Fed.
The Treasury plan would empower the Fed to collect information from commercial banks, investment banks, insurance companies, hedge funds, private equity funds and commodity pool operators, but it would not focus on the health of particular institutions.
Rather, during financial emergencies such as the current one, the Fed would have broad powers to order “corrective action” by the institutions to “deal with deficiencies that pose threats to our financial stability,” Mr. Paulson said.
The Fed’s new role as “super-cop” of global financial markets represents a “third mandate” that would potentially be as important as its dual mission of maintaining price stability and full employment, already assigned by Congress, said Doug Roberts, chief investment strategist for Channel Capital Research.
“This proposal is merely the first step in a long birthing process,” he said. “There will be long discussions between the legislative and executive branches. This will occur no matter who wins the White House in November.”
Ellen Seidman, former director of the Treasury Department’s Office of Thrift Supervision, said the proposal “does not deal with the root causes of our current crisis: regulatory authority without the will to exercise it, information gathering without enforcement based on that information, risk-taking without consequences.”
Anthony Sabino, a law professor at St. John’s University, said today’s problems are the result of aggressive deregulation that allowed banks to “wildly speculate” in securities markets and “in effect left big banks unanchored in the stormy seas of the market.” Turning the Fed into “super-regulator” will not cure that problem, he said.
“While this is intended to magnify the Fed’s already awesome power to better prevent problems, it would also greatly magnify a crisis when the Fed is slow to act or simply fails to recognize a looming problem,” he said.
MAJOR OVERHAUL
Highlights of the Bush administration’s 218-page plan to overhaul financial regulation:
•Create a federal Mortgage Origination Commission to develop uniform, minimum licensing standards for mortgage market participants.
•Close the Office of Thrift Supervision, which regulates savings and loans, and move those functions to the Office of the Comptroller of the Currency, which regulates banks.
•Merge the functions of the Commodity Futures Trading Commission into the Securities and Exchange Commission to create one agency to provide unified oversight of the futures and securities industries.
•Establish an Office of National Insurance within the Treasury Department to oversee those in the insurance industry who want to operate under an optional federal charter.
•Work to establish three major regulators. The Federal Reserve would serve as a “market stability regulator” to oversee the stability of the entire financial system. A “prudential financial regulator” would take over the functions of several separate banking regulators. A “business conduct regulator” would take over many of the functions of the Securities and Exchange Commission, as well as supervising consumer protection across all types of financial firms.
Source: Associated Press
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