Washington, Wall St. Tangle on Oversight

Saturday, March 29, 2008 10:22 AM

NEW YORK -- One of the casualties of the ongoing credit crisis is a long-held notion on Wall Street - that the investment banking community can take care of its own problems.

Everyone from Barack Obama to the Bush administration is floating ideas about how to strengthen oversight of financial institutions after decades of deregulation. And the government is expected to weigh in Monday with a plan to overhaul regulation of entire financial services industry, from banks and securities firms to mortgage brokers and insurance companies.

The administration's plan, detailed in an executive summary obtained by The Associated Press, would give the Federal Reserve broad power to oversee the stability of the financial markets. While the proposal is the result of a year-long review, and therefore predates the beginning of the credit crisis, it does come as debate was already under way about the government's role in the markets - particularly after the Fed intervened two weeks ago to save Bear Stearns Cos. from collapse by engineering its sale to JPMorgan Chase & Co.

Many on Wall Street have viewed increased government regulation of investment houses, including an expanded role for the Fed as a regulator, as a tricky balancing act. The fear among analysts is that too much regulation could hamper the companies' ability to drive profits, and in turn shift an increasing amount of business to financial centers overseas.

But the trade group representing the securities industry did react positively to news of the administration's plan, which is expected to be detailed Monday in a speech by Treasury Secretary Henry Paulson, a former Goldman Sachs Group Inc. chief executive.

"Treasury has delivered a thoughtful and sweeping plan which should provoke intense discussion, debate and potential legislative changes," said Tim Ryan, president of the Securities Industry and Financial Markets Association.

"Our present regulatory framework was born of Depression-era events and is not well suited for today's environment where billions of dollars race across the globe with the click of a mouse," Ryan said in a statement.

But regulation is a painful subject for investment houses, particularly as they try to recover from billions of dollars in losses over the past year from bad investments in risky mortgage-backed securities.

"We're in perilous times, and that's why we have to tread very carefully," Mark Bloomfield, president of the Washington-based American Council for Capital Formation, said before news of the administration's plan. "There are some that are skeptical of the free market, and others who say don't touch the free market because you don't know the unintended consequences."

Typically, Wall Street's big players have taken the lead in fixing their own problems in a financial survival of the fittest - historically, when one company has been in trouble, a competitor or competitors have taken it over. It has been rare for the government to take a hands-on approach to bailing out the financial sector - though that clearly is changing, and will affect how investment banks operate.

The proposal to be outlined Monday, among other things, would allow the Fed, in its new role as "market stability regulator," to dispatch examiners to check the books not just of commercial banks but of all segments of the financial services industry.

Some lawmakers and government officials contend the problems at Bear Stearns might have been prevented with more oversight. Once the nation's fifth-largest investment bank, Bear Stearns used massive amounts of leverage to buy mortgage-backed securities - a tactic that proved disastrous when the market collapsed amid a wave of foreclosures.

Paulson already this past week endorsed giving the central bank greater regulatory scrutiny. He has called the current system an "alphabet soup" of federal and state regulators, and wants to see the Fed take the lead.

Meanwhile, Obama, in a campaign speech, called for a "21st-century regulatory framework" that includes direct Fed oversight of all institutions, minimum liquidity and capital requirements, and enhanced rules for "complex financial instruments" used by investment banks.

Indeed, Wall Street has had its own alphabet soup to wade through in the past year. Investment banks have been managing speculative off-balance sheet products like structured investment vehicles, or SIVs; they've been relying on portfolios packed with asset-backed securities, or ABS, and collateralized debt obligations, or CDOs.

"The financial wizards who created this new market did not themselves understand precisely how leveraged they allowed themselves to become and, as a result, did not adequately protect against the risks," said Harvey Pitt, who served as chairman of the Securities and Exchange Commission between 2001 and 2003.

"We need a single regulatory body like the UK's Financial Services Authority," Pitt said in an interview with The Associated Press. "One that practices prudential regulation and tries to help people get it right, rather than the current philosophy of punishing people after the fact."

There are fears that over-regulation could damage the big Wall Street firms, thereby hurting the U.S. financial system and pushing more financial transactions overseas to cities like London, Frankfurt and Hong Kong. Still, those markets are suffering along with Wall Street as a result of the credit crisis.

The government's plan will be the subject of much debate - especially on Tuesday, when the Senate Banking, Housing and Urban Affairs Committee holds a hearing on the financial markets. Witnesses will include Paulson, Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson, Securities and Exchange Commission Chairman Christopher Cox - and the CEOS of Bear Stearns and JPMorgan Chase.

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