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Feds move to toughen financial oversight

A presidential panel is announcing steps to strengthen oversight of complex financial instruments partly blamed for the global financial crisis.
/ Source: The Associated Press

A White House panel's action to strengthen oversight of complex financial instruments partly blamed for the ongoing global crisis is viewed as a constructive step, but falls short of the tighter regulation many experts have advocated.

The actions announced Friday by the President's Working Group on Financial Markets are designed to bring more openness to the opaque, murky world of derivatives and credit default swaps — a type of corporate debt insurance — that have played a role in the worst financial calamity since the 1930s.

In one move, the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission agreed to exchange information on credit default swaps from private groups that will be set up to act as central clearinghouses for such transactions. That should help provide crucial information on the parties involved in the complex and unregulated products, bringing needed transparency to a $60 trillion worldwide market and possibly reducing financial risks.

The announcement came as President George W. Bush and other major world leaders were gathering in Washington for a summit to consider ways to battle the financial crisis, which is threatening to plunge the world economy into a recession.

The White House group also called for public reporting of prices, trading volumes and other information on credit default swaps in a bid to enhance market transparency for industry players and the public.

Yet marshaling information is a milder remedy than imposing regulation, which many feel is needed to bring the market for credit default swaps under government supervision. The approach taken by the White House group, headed by Treasury Secretary Henry Paulson and including Fed Chairman Ben Bernanke and SEC Chairman Christopher Cox, is favored by the financial industry.

The White House group took a similar tack last year with regard to hedge funds, vast pools of capital that operate secretively with scant government oversight, rejecting new regulation in favor of improved voluntary standards for hedge fund managers and investors.

Establishing central clearinghouses for credit default swaps "still allows some gaming of the system," said James Cox, a Duke University law professor and securities law expert.

He said the White House group's action shows "an unwillingness to recognize" that a free-market, hands-off approach to government regulation was a root cause of the credit crisis.

"It's kind of what you'd expect from a bumble-and-stumble group," said Cox. "It's time to have a new playbook."

Credit default swaps played a large role in the credit crisis that brought the downfall in September of Lehman Brothers Holdings Inc., pushed giant insurer American International Group Inc. to the brink of bankruptcy, and forced Merrill Lynch & Co. to sell itself to Bank of America Corp. The swaps are commonly used contracts to insure against the default of financial instruments such as bonds and corporate debt. But they also are bought and sold as bets against bond defaults.

"It should have happened sooner," Michael Williams, dean of Touro College's Graduate School of Business in New York, said of the White House group's move. "A step in this direction is the right step."

Cox, the SEC chairman, has urged Congress to rein in the market for credit default swaps with new legislation to regulate it. The legislation should empower the SEC and the CFTC to implement new rules designed to combat fraud in that market, he has said.

The market for the swaps has provided a "significant opportunity" for market manipulation, according to Cox. The SEC has undertaken a sweeping investigation of the market, looking at whether investors used credit default swaps to illegally profit from sharp declines in stocks of financial companies.

The White House group on Friday did urge regulatory agencies to review whether they have adequate authority to police against fraud and market manipulation, and to propose changes if needed.

The panel also said that regulators should have access to information about trades and positions on the investments for the purpose of "monitoring market trends, identifying potential issues, and preventing market manipulation and insider trading." It said regulators in the U.S. and abroad should expand their efforts to share information.