Federal Reserve policy makers are redefining which companies are vital to the flow of credit, an area once the sole domain of commercial banks, and which institutions pose risks to the entire economy if they fail. Treasury Secretary Henry Paulson said in a speech yesterday that the Fed should broaden its oversight to include Wall Street investment firms, now regulated by the Securities and Exchange Commission.
Former regulators predict the changes will see the Fed accrue influence at the expense of the SEC, which was created by President Franklin Roosevelt to make rules for dealers and stock exchanges. The Fed is taking almost $30 billion in assets off Bear Stearns's balance sheet to encourage JPMorgan Chase & Co. to buy the firm, even though Bear's main supervisor is the SEC.
``This is tectonic,'' said Ralph Ferrara, a former general counsel at the SEC, and now a partner at Dewey & LeBoeuf LLP in Washington. ``We no longer want to have a balkanized response to a national crisis.''
In 2006, New York Fed President Timothy Geithner, saw the need to ``revisit'' the Fed's authority. In a panel discussion on Sept. 26 of that year, he said the Fed supervised a ``diminished'' portion of the system as securities firms and hedge funds grew in influence. Paulson is finishing his own review.
`View of Potomac'
The SEC will be so diminished that it ``will be given a nice view of the Potomac from whatever floor of the comprehensive financial services regulator they are given,'' said Ferrara.
Geithner has already redrawn the lines, invoking a little- used authority to push the Fed into the role of an orderly bank liquidator, much like the Federal Deposit Insurance Corp., by helping finance and sell $30 billion of illiquid Bear Stearns securities.
``Because of financial innovation, we have lots of these financial firms that started to look like banks,'' said Mark Gertler, a New York University professor and visiting scholar at the New York Fed. ``Any institution that may need to go to the discount window directly or indirectly ought to be under the supervisory control of the Fed.''
As Paulson addressed the U.S. Chamber of Commerce yesterday, the Senate Finance and Banking committees said they are reviewing the Bear Stearns sale.
``We want to know the extent to which Paulson was involved in the deal, whether it was done by an independent Fed on their own impetus,'' Charles Grassley, the top Republican on the panel, said in an interview with Bloomberg Television. He said he doubted Congress would try to block the deal.
Legislators are already considering a new regulatory structure. House Financial Services Chairman Barney Frank said last week Congress should consider creating an agency to monitor market risk or give that authority to the Fed. The Massachusetts Democrat also said he will seek less duplication. Currently, there are five separate regulators of banks, thrifts, and credit unions.
Congress may not control the debate over the future of the Fed, SEC and other regulators because many of the institutions are already redefining their roles in the credit crunch.
FDIC Chairman Sheila Bair has been praised by consumer advocates for pushing lenders toward a voluntary mortgage modification program.
For the first time since the 1930s, the Fed extended credit to non-bank corporations, lending $28.8 billion as of March 19 to bond dealers, including Morgan Stanley and Goldman Sachs Group Inc. The Fed said on March 16 that the facility will be available for at least six months.
``You need to follow the money,'' said David Becker, a former SEC general counsel and now a partner at Cleary Gottlieb Steen & Hamilton LLP in Washington. ``The fact that the Fed has now put up a great deal of money in dealing with an investment bank means they are going to want, and may well get, a more active regulatory role.''
The SEC was created to restore confidence in markets after the 1929 stock-market crash and the Depression. The agency's mandate is to make sure investors are treated fairly, and it enforces rules for both companies that sell stock to the public and people who sell and trade securities.
``While each of the agencies has different roles and responsibilities, together we bring our collective authorities to bear on behalf of investors and capital markets,'' said John Nester, a spokesman for the SEC in Washington.
On Wall Street and in Washington, the SEC has a reputation as a much stronger enforcer and prosecutor of malfeasance than the central bank. Congress blamed the Fed for lax consumer protection during the housing boom and has threatened to strip or share its consumer protection powers.
``Bank regulators have, in general, been good at worrying about the safety and soundness of banks,'' said Harvey Goldschmid, a former SEC commissioner who's now a professor at Columbia Law School in New York. ``They have not, however, been strong on protecting consumers and investors.''