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Paulson To Urge New Fed Powers
Bank Would Help Police Wall Street

By Neil Irwin
Washington Post Staff Writer
Thursday, June 19, 2008

Treasury Secretary Henry M. Paulson Jr. plans to call today for the Federal Reserve to be given new, explicit powers to intervene in the workings of Wall Street firms to protect the financial system, adapting his vision of how the financial world should be regulated to reflect the lessons of the collapse of Bear Stearns.

"Our nation has come to expect the Federal Reserve to step in to avert events that pose unacceptable systemic risk," Paulson plans to say in a speech today, according to prepared remarks obtained by The Washington Post. But the central bank "has neither the clear statutory authority nor the mandate to anticipate and deal with risks across our entire financial system."

"We should quickly consider how to appropriately give the Fed the authority to access necessary information from highly complex financial institutions and the responsibility to intervene in order to protect the system," Paulson plans to say, "so they can carry out the role our nation has come to expect."

Over the course of a few days in March, the central bank took unprecedented steps, with Paulson's support, to keep the rapid dissolution of Bear Stearns from causing an international financial catastrophe. The Fed provided financial backing for the acquisition of the investment bank by J.P. Morgan Chase and made emergency loans available to all major investment firms.

Those steps upended decades of precedent for how the financial sector was regulated. They also prompted a broad rethinking of how the government should try to prevent the actions of an individual firm from endangering everyone. Top officials are now, after several months, presenting their thoughts on what should come next; New York Fed President Timothy F. Geithner did so last week, for example, and Federal Deposit Insurance Corp. Chairman Sheila C. Bair did the same in a speech yesterday.

Any new formal regulatory powers for the Fed would have to be passed by Congress.

Paulson's recommendations go beyond those contained in a blueprint for financial regulation that he unveiled shortly after the Bear Stearns rescue. That document, which had been in the works for more than a year, proposed an enhanced role for the Fed in preempting financial crises but offered few details. Today's speech will elaborate, calling for the Fed to be given explicit power to step in whenever a firm poses risks to the system and the authority to demand information from financial institutions so it can better anticipate emerging threats.

Paulson's argument, which is shared by leaders of the Fed, is that even when the emergency Fed lending program for investment banks goes away -- it is scheduled to expire in September, though the central bank could choose to extend it -- financial players will assume they would be bailed out again in a crisis. That means they may be more willing to take risks that could threaten the financial system and thus require greater policing.

"We must limit the perception that some institutions are either too big to fail or too interconnected to fail," Paulson is to say. "If we are to do that credibly, we must address the reality that some are."

In many ways, Paulson's comments echo those by Geithner last week. For example, in today's speech, Paulson is to urge that the trading of financial products called over-the-counter derivatives be standardized. That has been a longtime goal of Geithner's.

Though Paulson and Geithner have collaborated in addressing the financial crisis of the past 10 months, the Treasury Department and the Fed still have some disagreements. Paulson, for instance, would move the Fed's day-to-day supervision of commercial banks to a different regulator in the name of simplification.

Fed leaders counter that their day-to-day regulation of banks gives them important insight into risks to the broader system. Indeed, they argue that the British regulatory system, which does separate the two roles, was a major reason for the run on the British bank Northern Rock last year that contributed to the financial crisis.

Bair, the chairman of the FDIC, made that point in her speech yesterday to the Exchequer Club of Washington. Her agency is responsible only for deposit insurance at regular, commercial banks, but she advocated a new system to handle the dissolution of any investment banks.

"I believe we need a special receivership process for investment banks that is outside the bankruptcy process, just as it is for commercial banks and thrifts," Bair said. "The bankruptcy process focuses on protecting creditors. When the public interest is at stake, as it would be here, we need a process to protect it."

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