Plan would make Fed a financial supercop

WASHINGTON — The Bush administration will propose Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability, in effect allowing the Fed to send SWAT teams into any corner of the industry or any financial institution that might pose a risk to the overall system.

The proposal is part of a sweeping blueprint to overhaul the nation's hodgepodge of financial regulatory agencies, which many experts say failed to recognize the rampant excesses in mortgage lending that set off the current economic turmoil.

According to an administration summary Friday, the plan would:

• Consolidate an alphabet soup of banking and securities regulators into a trio with greater oversight of Wall Street investment banks, brokerage firms, hedge funds, private equity firms and — for the first time — insurance companies.

• Give the Fed some authority over Wall Street firms, but only when an investment bank's practices posed a threat to the entire financial system.

What the plan would not do:

• It carefully avoids a call for tighter regulation. For example, it would not rein in the practices that have been implicated in the housing and mortgage meltdown, such as packaging risky subprime mortgages into securities carrying the highest ratings.

• It does not recommend tighter rules over the vast and largely unregulated markets for risk-sharing and hedging, like credit-default swaps, which are supposed to insure lenders against loss but became a speculative instrument themselves and gave many institutions a false sense of security.

The plan's chances

Because the proposal would affect scores of deeply entrenched industry groups, it is likely to provoke bruising turf battles in Congress between rival agencies and rival industry groups that benefit from the current system of regulation.

Administration officials acknowledged Friday that they did not expect the proposal to become law this year, but said they hoped it would help frame a policy debate that would extend well after the elections in November.

The proposal began to take form last year as an effort by Treasury Secretary Henry Paulson to make American financial markets more competitive against overseas markets by modernizing a creaky regulatory system. His goal was to streamline the different and sometimes clashing rules for commercial banks, thrifts and nonbank mortgage lenders.

"I am not suggesting that more regulation is the answer, or even that more effective regulation can prevent the periods of financial market stress that seem to occur every five to 10 years," Paulson will say, according to a draft of a speech he plans to deliver on Monday. "I am suggesting that we should and can have a structure that is designed for the world we live in, one that is more flexible."

Bigger role for Fed

Almost every element of the proposal would have to be approved by Congress, where Democratic leaders are already drafting their own bills to impose tougher supervision over Wall Street.

But Paulson's proposal for the Fed echoes ideas championed by Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.

Both see the Fed taking a central role in overseeing risk across the entire financial spectrum, but Frank is likely to favor a stronger Fed role, and to subject investment banks to the same rules that commercial banks now must follow, especially for capital reserves.

Under the Treasury proposal, the Federal Reserve would become the government's "market stability regulator" and would be allowed to gather information from virtually any kind of financial institution. Fed officials would be allowed to examine the practices and even the internal bookkeeping of brokerage firms, hedge funds, commodity-trading exchanges — anything that might pose a risk to the overall financial system.

"The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability," Paulson will say in his speech.

That would be a significant expansion of the central bank's regulatory mission, which has been limited primarily to supervising commercial banks.

When Fed officials agreed earlier this month to rescue Bear Stearns, once the nation's fifth-largest investment bank, they pointedly noted that the Fed never had the authority to monitor the institution's financial condition or order it to beef up its protections against a collapse.

In an unprecedented pair of moves, the Fed engineered a shotgun marriage between JPMorgan Chase and Bear Stearns, lending $29 billion to JPMorgan to prevent a Bear bankruptcy and a chain of defaults that might have brought down much of the financial system.

For the first time since the 1930s, the Fed also agreed to let investment banks borrow hundreds of billions of dollars from its "discount window," an emergency lending program reserved for commercial banks and other depository institutions.

A diminished SEC

In addition to putting the Fed in charge of "market stability," the proposal would consolidate a large number of regulatory agencies into roughly three big new ones:

• Banks: Bank supervision, now divided among five different federal agencies, would be rolled into one, which would have the power to send examiners into any bank protected by either federal deposit insurance or other federal backstops. It would also eliminate the distinction between "banks" and "thrift institutions," which are already indistinguishable to most consumers, and shut down the Office of Thrift Supervision.

• Stocks and commodities: The Securities and Exchange Commission (SEC), which regulates the stock and bond markets and protects investors, would be merged with the Commodity Futures Trading Commission, which regulates futures for oil, grains, currencies and the like.

Some of the reforms could actually reduce the power of the SEC. The blueprint suggests several areas where the SEC should take a lighter approach to its oversight. Among them are allowing stock exchanges greater leeway to regulate themselves.

• Insurance: The plan would, for the first time, create a national regulator for insurance companies, an industry now regulated by state governments that would probably not welcome federal encroachment.