Feds try to catch up to financial world

WASHINGTON — If big Wall Street investment houses are allowed to run to the Federal Reserve for emergency lending, they must face stepped-up regulation, Treasury Secretary Henry Paulson declared Wednesday.

The demise of once-mighty Bear Stearns proves "the world has changed," underscoring a need for the government to adapt, too, he said.

The Bush administration will soon provide an oversight blueprint in an effort to promote smoother functioning of financial markets, Paulson said in a speech to the U.S. Chamber of Commerce.

The implosion of investment house Bear Stearns and fears that others could be in jeopardy have sent tremors through trading rooms of Wall Street, government corridors and many American living rooms.

The events have raised new questions about whether regulations need to be revamped to better keep up with the world of modern finance and to avert a repeat of the credit chaos confronting the country.

Commercial banks, a national financial bedrock, are subject to regulations, including bank examinations and rules for submitting detailed financial information, to help regulators gauge their safety and soundness.

However, the modern U.S. financial system has become a complex web of players subject to widely different rules.

"This latest episode has highlighted that the world has changed, as has the role of other nonbank financial institutions and the interconnectedness among all financial institutions," Paulson said.

"These changes require us all to think more broadly about the regulatory and supervisory framework that is consistent with the promotion and maintenance of financial stability," Paulson added.

In extraordinary actions aimed at preventing a meltdown of the U.S. financial system, the Federal Reserve recently backed JPMorgan Chase's takeover of Bear Stearns and agreed to provide a multibillion-dollar lifeline for the deal.

In addition, the Fed, in the broadest use of its lending authority since the 1930s, said it would let squeezed Wall Street investment houses come to it directly for emergency loans. Such access has long been limited to commercial banks.

Paulson said he supported that action but added it raised important policy considerations about the oversight of investment houses.

He said commercial banks' access to the Fed's emergency lending "discount window" has traditionally been accompanied by regulatory oversight and supervision. "Certainly any regular access to the discount window should involve the same type of regulation and supervision," he said.

And he suggested the Federal Reserve collect as much information as necessary on investment houses to "make informed lending decisions." He said the Fed is working to do that.

Paulson suggested the Fed, the Securities and Exchange Commission and the Commodity Futures Trading Commission also continue to work to build a framework on this.

These steps, he said, "would enable the Federal Reserve to protect its balance sheet and ultimately protect U.S. taxpayers," he said.

Paulson defended the government's role in coming to the aid of Bear Stearns, an action that has been criticized by some Democrats and others as akin to a federal bailout.

"Bear Stearns found itself facing bankruptcy," Paulson said. "The Federal Reserve acted promptly to resolve the Bear Stearns situation and avoid a disorderly wind-down. It is the job of regulators to come together to address times such as this, and we did so. Our focus was the stability and orderliness of our financial markets."

On the broader situation, he said it's too soon to conclude that other potentially important financial firms should have permanent access to the Fed.

He also said the Federal Reserve's action so far "should be viewed as a precedent only for unusual periods of turmoil."

Some lawmakers were still skeptical.

Sen. Max Baucus, D-Mont., the Senate Finance Committee chairman, and Charles E. Grassley of Iowa, the panel's top Republican, demanded details about the Bear Stearns sale and any possible effect on taxpayers. They asked Paulson and Fed Chairman Ben Bernanke to give them specifics by the end of the week.

Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, summoned Paulson, Bernanke, Bear Stearns President Alan Schwartz, JPMorgan Chairman Jamie Dimon and others to appear before his panel next Thursday to lay out the rationale behind the Bear Stearns takeover deal and its implications for taxpayers.

The Fed originally agreed to guarantee $30 billion of Bear Stearns assets, including risky mortgage-backed securities. Under new terms reached this week, JPMorgan said it will take on the first $1 billion of losses, while the Fed backs the remaining $29 billion.

Those were signs that Congress has placed the financial crisis at the top of the election-year agenda, with investigations and legislation likely.

With home foreclosures at record highs, Paulson said the administration will explore more ways to help distressed homeowners. But he was cool to some Democratic proposals, saying that "most are not yet ready for the starting gate."

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, wants new regulations on investment banks similar to those that apply to regular banks.

That includes mandatory requirements for cash reserves to cushion losses.

The Fed or another government entity should be designated as a "financial-services regulator" with the power to limit risky practices, Frank said.

Associated Press reporter Julie Hirschfeld Davis contributed to this story.