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Regulators step up investment bank oversight

Federal regulators told lawmakers Thursday they have stepped up their supervision of large investment banks in a bid to contain risk following the near-collapse of Bear Stearns.
/ Source: The Associated Press

Federal regulators told lawmakers Thursday they have stepped up their supervision of large investment banks in a bid to contain risk following the near-collapse of Bear Stearns Cos and turmoil in the financial markets.

At the same time, a rising chorus of Bush administration officials and independent regulators urged prompt changes — either by giving more power to the Federal Reserve or the Securities and Exchange Commission — to meet the threat of a financial system breakdown.

Erik Sirri, director of the SEC’s trading and markets division, said new legislation spelling out how, and by which regulators, big investment banks should be supervised is “an imperative from the Bear Stearns crisis.”

Donald Kohn, vice chairman of the Federal Reserve, said the central bank is coordinating with the SEC to monitor large investment banks, which in general, “are strengthening liquidity and capital positions to better protect themselves against extreme events.”

Thursday’s hearing of the Senate Banking subcommittee on securities came soon after Treasury Secretary Henry Paulson said the government must quickly give the Federal Reserve greater power to regulate the financial system.

In light of the Bear Stearns debacle, the central bank’s powers should be expanded, Paulson said in a speech to a women’s business group in Washington. Policymakers must quickly consider how to give the Fed the authority it needs to protect the overall financial system, he said.

Hours before the Senate hearing convened, Wall Street was treated to the spectacle of a “perp walk,” as two former Bear Stearns managers were arrested on securities fraud and other charges linked to the collapse of a hedge fund that bet heavily on subprime mortgages before the market collapsed. They were the first high-level executives to be charged in connection with the crisis that has rocked the financial markets.

Since the stunningly swift decline and $29 billion government-backed rescue in mid-March of Bear Stearns, regulators, policymakers and legislators have been debating whether investment banks should come under tighter government controls.

In some areas, such as limits on how much a financial institution can borrow relative to its capital, investment banks are less tightly regulated than commercial banks.

Anxiety also has been festering on Wall Street and among analysts that a full-fledged bank failure could occur if losses from mortgage-backed securities continue to mount. Estimates of damage from the mortgage market debacle have been rising, with the grimmest forecasts putting total losses as high as $945 billion.

While Congress appears unlikely to address the thorny issue of overhauling financial regulations this year, initial discussions are beginning. Lawmakers may consider a proposal that would empower regulators such as the SEC and the Fed to intervene — and possibly to shut down — investment banks that fail to meet federal requirements for minimum levels of capital held against risk.

On Wednesday, the head of the Federal Deposit Insurance Corp. said the government must do a better job of contingency planning for the failure of a large investment bank. FDIC Chairman Sheila Bair said regulation of investment banks should more closely resemble that of commercial banks.

One possibility would be for the FDIC to take over and run a failing investment bank after the Fed or the SEC decided to shut it down, Bair said. The FDIC already does so for failed commercial banks.