Fed, SEC Team Up On Bank Oversight

Fed Chairman Ben S. Bernanke is considering whether to extend a special lending program for investment banks that is scheduled to end in September.
Fed Chairman Ben S. Bernanke is considering whether to extend a special lending program for investment banks that is scheduled to end in September. (By Chip Somodevilla -- Getty Images)
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By Neil Irwin
Washington Post Staff Writer
Tuesday, July 8, 2008

Two top regulators reached a formal agreement to coordinate their oversight of Wall Street yesterday, as the government attempts to build a new system to guard against a meltdown of the financial system.

Leaders of the Federal Reserve and the Securities and Exchange Commission signed a memorandum of understanding that explicitly allows for the two agencies to share information about the inner workings of investment banks. The move formalizes what has been a reality since the rescue of Bear Stearns in March and marks an end to an era in which the two agencies held information close to their vests.

"It requires consultation between the SEC and the Fed in areas that the SEC had thought previously were its exclusive business. But the world has changed," said David Becker, a partner at law firm Cleary, Gottlieb, Steen & Hamilton and former general counsel at the SEC. "This mostly ratifies facts on the ground."

The agreement is a baby step in a broader path toward changing the way the nation's financial system is regulated. The Bush administration proposes streamlining the oversight of banks and investment firms while giving the Fed new powers to guard against financial crises. Fed Chairman Ben S. Bernanke will address the topic in a speech today and in congressional testimony Thursday.

Bernanke is considering whether to extend a special lending program for investment banks, implemented during the Bear Stearns episode, that is scheduled to end in September. He is considering extending that program beyond the end of the year if the strains in financial markets continue.

Currently, investment banks voluntarily agree to have the SEC as their primary regulator, a situation that Bernanke worries weakens the SEC's oversight ability. In his view, and that of many experts outside the government, Congress should grant stronger legal authority to those who regulate investment firms.

Bernanke also favors exploring new procedures by which the government can ensure that if investment firms fail, they could do so in a way that inflicts less damage on the overall economy. Such a formal procedure, which is in place for regular banks, might have made the dissolution of Bear Stearns more orderly.

The Fed chairman is open to taking on formal responsibility for the stability of the financial system, which the Bush administration advocates, but to do so the central bank wants the ability to gather information and order changes in a wide range of financial companies.

Any major overhaul will require changes to the law -- a sprawling and complicated task that is unlikely to happen this year. Yesterday's agreement shows how the agencies involved are trying to find ways to prevent a recurrence of the financial crisis in March using the tools and legal authority they already have.

"Once you try to do a major overhaul, you get into a lot of turf wars and you can get very bogged down," said Martin Neil Baily, a senior fellow at the Brookings Institution. "This is working within the existing system, which can be a more effective way to go."

The SEC-Fed agreement came about because of what happened in March, when the Fed agreed to make an emergency loan to Bear Stearns, which otherwise would have filed for sudden bankruptcy, and then gave financial backing to the acquisition of Bear Stearns two days later. The Fed also made loans available to all investment banks, to prevent the run on the bank that enveloped Bear Stearns from bringing down other major firms.

As it made those loans, leaders of the Fed insisted they get new access to the inner workings of the investment firms so as to be sure that their loans would be paid back. New York Fed employees have been working alongside SEC regulators in the large banks since March, doing just such monitoring.

Under current law, the SEC is the primary regulator of investment banks, such as Goldman Sachs and Morgan Stanley, while the Fed has explicit authority over commercial banks such as Citigroup and Bank of America. But that distinction has become increasingly blurry in a world in which commercial banks have big investment banking arms and investment firms are so intertwined in world markets that their downfall could threaten the world economy.

According to the new agreement, the SEC will provide the Fed with "information and analysis regarding the financial condition, risk management systems, internal controls and capital, liquidity and funding resources" of the firms it oversees, and the Fed will do likewise for the SEC.

"This agreement will permit the expanded sharing of information on a confidential basis," said SEC Chairman Christopher Cox in a statement, "and help ensure that regulated entities receive a coherent message from Uncle Sam."

Congressional Democrats praised the agreement while saying that there is still major work to be done to make financial regulation more effective.

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