WASHINGTON Two days before Congress rolls up its sleeves and begins to consider new regulation of financial markets, Federal Reserve Chairman Ben Bernanke on Tuesday called for additional powers to look more closely at investment banks, with an eye toward preventing a future collapse of the global banking system.
The Federal Reserve also will issue new rules next week aimed at protecting future homebuyers from dubious lending practices, its most sweeping response to a housing crisis that has propelled foreclosures to record highs.
When the head of the Fed calls for greater financial regulation, echoing Treasury Secretary Henry Paulson, a former Wall Street titan, it's significant. It signals a growing shift in the nation's capital toward embracing stronger regulation of financial markets, after at least a quarter-century of a more hands-off approach.
"It is going to be a turn back towards more regulation, but it's not going to be so easy," said Barry Bosworth, a presidential adviser in the 1970s who's now a senior economics fellow at the Brookings Institution. "They've got a dilemma that some of these new financial instruments, and markets, have become so complex. If they continue to let them operate, it's not clear that the regulators will be able to keep up."
Vincent Reinhart agrees. Until recently, he was the chief economist of the Fed's interest rate-setting Open Market Committee. Reinhart, too, thinks that significantly stronger regulation is coming.
"It's quite possible that in the spring of next year, we will have the most significant reregulation in memory, and I don't think it's (in the last) 25 years. I think it's 75 years, and you've got to go back to 1933" and the Great Depression, said Reinhart, who's now an analyst at the American Enterprise Institute.
Bernanke signaled clear support for congressional and Bush administration efforts to bolster existing financial regulations when he spoke Tuesday to a Federal Deposit Insurance Corp. forum outside Washington. He supported expanded Fed powers to guard against systemwide shocks to global finance but cautioned that his agency needs Congress to grant it explicit authority, which it now lacks.
"The financial turmoil since August underscores the need to find ways to make the financial system more resilient and stable," Bernanke said.
The recent collapse of investment bank Bear Stearns is driving the push for new regulation. The Fed was forced to step in on March 14, and over a single weekend, broker the fire sale of Bear Stearns to rival JP Morgan Chase. The Fed also opened its discount window, where it acts as the lender of last resort, to investment banks, which it doesn't regulate. This window traditionally has been open only to commercial banks, which are under the Fed's supervision.
The Fed lacked explicit authority to take over an investment bank, as former Fed Chairman Paul Volcker has suggested, but Bernanke maintains that the move was legal because the Fed has broad responsibility to protect the U.S. financial system from collapse.
Since then, Treasury Secretary Paulson, a former chairman and chief executive officer of investment bank Goldman Sachs & Co., has offered a blueprint for revamping the regulation of financial markets. He recently said that some of his proposals shouldn't wait.
On Thursday, the House Financial Services Committee will hold the first of several hearings on the state of financial-market regulation and the safety and soundness of the banking system. Bernanke and Paulson are scheduled as the lead-off witnesses.
Before the hearings, Bernanke spelled out what he wants from Congress: a new, more robust framework for regulating investment banks, which aren't subject to supervision and capital requirements, unlike commercial banks.
The Securities and Exchange Commission has oversight of the holding companies that own investment banks, but the oversight is based on voluntary agreements with the banks.
"Strong holding-company oversight is essential, and thus, in my view, the Congress should consider requiring consolidated supervision of those firms, providing the regulator the authority to set standards for capital, liquidity holdings and risk management," Bernanke said.
To prevent a repeat of the current mortgage mess, Bernanke said the Fed also will adopt rules cracking down on a range of shady lending practices that have burned many of the nation's riskiest "subprime" borrowers those with spotty credit or low incomes who were hardest hit by the housing and credit debacles.
The plan, which will be voted on at a Fed board meeting on Monday, would apply to new loans made by thousands of lenders of all types, including banks and brokers.
Under the proposal unveiled last December, the rules would restrict lenders from penalizing risky borrowers who pay loans off early, require lenders to make sure these borrowers set aside money to pay for taxes and insurance and bar lenders from making loans without proof of a borrower's income. It also would prohibit lenders from engaging in a pattern or practice of lending without considering a borrower's ability to repay a home loan from sources other than the home's value.Consumer groups have complained that the proposed rules aren't strong enough, while mortgage lenders worry that they are too tough and could crimp customers' choices.
Contributing: Associated Press