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Bernanke puts heat on Congress to reform financial regulation
New powers needed to oversee complex firms, Fed chairman says

By Neil Irwin
Saturday, October 24, 2009

CHATHAM, MASS. -- Federal Reserve Chairman Ben Bernanke stepped up pressure on Congress on Friday to overhaul financial regulation, using his bully pulpit to try to provide a boost to plans that have moved slowly on Capitol Hill.

Seven months after the Obama administration laid out its blueprint for reforming financial regulation, the gears of the legislative process have moved slowly, particularly in the Senate. A House committee on Thursday approved creating a new regulator meant to protect consumers of financial products, but many key questions remain in flux, such as how much power the Fed or another regulator should have to oversee large, complex firms.

Meanwhile, Bernanke, who awaits Senate confirmation for a second four-year term, views finding fixes that will prevent or lessen the impact of future crises as one of his two key goals for the coming years. The other is to undo the Fed's exceptional efforts to support the economy in a manner that neither spurs another recession nor a burst of inflation.

"Regulators and supervisors can do a great deal, but comprehensive financial reform requires action by the Congress," Bernanke said Friday at a conference sponsored by the Federal Reserve Bank of Boston. He specifically called for giving regulators new powers to oversee financial companies whose size and complexity threaten the entire financial system, as well as the power to close them down in an orderly way should they fail.

At the same conference Friday, Fed Vice Chairman Donald L. Kohn, one of Bernanke's closest collaborators, embraced similar ideas, but noted that it could take time to develop a resilient new system of financial regulation.

"I hope we build a regulatory structure that's good for a couple of decades, and it's worth taking our time to get it right," Kohn said.

Bernanke spoke in support of forming an oversight council involving the major financial regulators to monitor trends that threaten the financial system as a whole. Some Fed critics on Capitol Hill would go further, giving such a group formal responsibility for managing those risks, instead of allotting those powers to the Fed.

Bernanke did not place the onus for improving financial regulation solely on Congress. He said that the Fed has used its existing powers to try to curtail some of the risky behavior on Wall Street and in the nation's banks that contributed to the crisis. He called for three tiers of reform: major structural changes enacted by Congress; new sets of regulations issued by the Fed; and new practices and procedures in the nitty-gritty of oversight by bank supervisors.

For example, on Thursday the Fed issued proposed guidance for regulating pay practices at the banks it supervises, aiming to keep executives, traders and other employees from being paid in ways that could endanger the safety and soundness of the bank.

The Fed is also adjusting its methods for supervising banks, trying to include more big-picture analysis of economic risks and trends, rather than examining the situation of individual institutions in a vacuum.

In particular, he targeted the current system that allows some massive financial firms to fall between the cracks of regulation, as was the case with the giant insurance company American International Group. "Large, complex financial firms that do not own a bank, but that nonetheless pose risks to the overall financial system, must not be permitted to avoid comprehensive and effective supervisory oversight," Bernanke said.

In calling for a new approach to winding down large, complex financial firms, he said that there must be a process in place to impose losses on shareholders and creditors of firms that fail, while shielding the overall economy. He added that any costs should be paid by the financial industry, not taxpayers.

"The bankruptcy code does not always protect the public's strong interest in avoiding the disorderly collapse of a non-bank financial firm that could destabilize the financial system and damage the economy," Bernanke said.

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