Monday, July 14, 2008

Police shouldn't police police

Priests shouldn't oversee their own, and investment bankers should not oversee themselves.

Financial 'super cop' role for Fed

By Caroline Hepker
Business Reporter, New York [BBC]

Ben Bernanke (right)  and Henry Paulson
The US wants to beef up its oversight of financial institutions

For decades, Wall Street has banged the drum for de-regulation.

In capitalist America, the idea that financial markets are best left alone has been dearly held. And it has helped make America rich.

But the bomb-shell of the near collapse of investment bank Bear Stearns and the credit crunch has exploded some of that confidence in self-policing markets.

Now, the financial system here in the United States could get its biggest shake-up since the Great Depression of 1933.

Size matters

On Thursday, America's two most powerful economic figures - the Federal Reserve chairman Ben Bernanke and the US Treasury Secretary Henry Paulson -addressed a Congressional panel on "Systematic Risk and Financial Markets".

They argued the case for a new type of regulation that would look at the bigger picture.

Rather than the type of institution, the key factor would be its importance within the financial system.

The problem is you are always regulating the past
Diane Swonk, chief economist, Mesirow Financial

Mr Paulson told the panel that the Bear Stearns rescue and the market turmoil it unleashed showed the "outdated nature" of the financial regulatory system.

"This has convinced me that we must move much more quickly to update our regulatory structure and improve both market oversight and market discipline," he said.

Mr Bernanke told Congress he supported that push for change.

"The financial turmoil is ongoing, and our efforts today are concentrated on helping the financial system return to more normal functioning.

It is not too soon, however, to think about steps that might be taken to reduce the incidence and severity of future crises."

He went on to suggest Congress may need to enact new laws to increase the Federal Reserve's powers.

Tectonic shift

This would take America's central bank into a new sphere.

Wall Street traders
Wall Street has traditionally preferred light touch regulation

Traditionally, the Fed has regulated commercial banks but investment banks have fallen under the oversight of the Securities and Exchange Commission.

So far, investment banks have been more lightly regulated thanks to a set of voluntary codes, meanwhile hedge funds have barely been regulated at all.

But the tectonic plates of US regulation shifted when the Federal Reserve stepped in to bail-out investment bank Bear Stearns.

In March, the 85-year-old investment firm experienced a run on the bank.

In order to avoid a bankruptcy that could have destabilised the entire financial system, Mr Bernanke helped negotiate, over a single weekend, for rival JP Morgan Chase to buy Bear Stearns.

With that, the door to greater Fed regulation of investment banks was opened.

At the same time, Mr Bernanke addressed the wider liquidity crunch on Wall Street with an extraordinary measure.

He pumped more cash into the system by offering the nation's biggest investment banks access to low-cost overnight loans, usually reserved for commercial banks only.

It was a measure that was meant to be temporary, but Mr Bernanke says he may well be extended into 2009.

Kneejerk regulation?

There is fear that the new regulations will go too far.

Diane Swonk, chief economist based in Chicago for Mesirow Financial recalls the last big regulatory push - in the wake of the collapse of energy trading giant Enron in 2001.

Federal Reserve building
Analysts warn that new regulations could go too far

Thousands of Americans lost jobs and life savings with the collapse of Ken Lay's company but the reaction was ill-thought out, says Ms Swonk:

"The problem is you are always regulating the past, that's what happened with Sarbanes-Oxley. Much of Sarbanes-Oxley was overkill. I hope there is enough memory of that for Congress to tread carefully."

Moreover, Ms Swonk says that greater regulation risks killing the golden goose altogether.

"My concern is where we sit internationally. The money will go somewhere, to even less regulated markets."

Congress will no doubt take this into consideration.

Super cop

So far, the chairman of the Federal Reserve though has been praised for his work in steering the financial crisis.

Unlike Mr Paulson, Mr Bernanke did not cut his teeth on Wall Street.

But the former academic seems determined to exert greater power over America's complex financial system and perhaps it will earn him a new nickname - the Fed's super cop.

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