WASHINGTON — A consensus is building around the need for more regulation of investment banks in the wake of the Federal Reserve Board's move to grant them access to the discount window.
Treasury Secretary Henry Paulson, himself a former investment bank executive, on Wednesday became the latest to call for more oversight.
"Access to the Federal Reserve's liquidity facilities traditionally has been accompanied by strong prudential oversight of depository institutions, which also has included consolidated supervision where appropriate," Mr. Paulson said. "Certainly any regular access to the discount window should involve the same type of regulation and supervision."
The rapidly growing list of policymakers who have made similar statements includes House Financial Services Committee Chairman Barney Frank, Senate Banking Committee Chairman Chris Dodd, and Sen. Charles Schumer, D-N.Y. Federal Reserve Board officials have also signaled a perceived need for such action.
Mr. Paulson did temper his support for more regulation somewhat, saying bank-like oversight for investment firms may only be necessary if access to the discount window were made permanent. This may not happen, he said.
"It would be premature to jump to the conclusion that all broker-dealers or other potentially important financial firms in our system today should have permanent access to the Fed's liquidity facility," he said in a speech to the U.S. Chamber of Commerce. "Recent market conditions are an exception from the norm. At this time, the Federal Reserve's recent action should be viewed as a precedent only for unusual periods of turmoil."
He also said there were good reasons why commercial and investment banks are overseen differently, noting that commercial banks have access to federally guaranteed insured deposits as a tradeoff for greater supervision.
But he emphasized the need for more oversight of investment banks on a temporary basis, at least. He urged the Fed to make more disclosures about what institutions are eligible to borrow at the discount window, when funds will be made available, and at what price.
He also said the Fed should have access to more information about institutions to which it is lending. He revealed that the Fed is already working with the Securities and Exchange Commission "within these institutions."
"We suggest that the Federal Reserve, the SEC, and the [Commodity Futures Trading Commission] continue their work of building a robust cooperative framework," he said, urging a more "formalized working agreement."
A Fed spokeswoman declined to comment, but central bank officials signaled as early as last year that investment companies would need more oversight if they had access to the discount window.
In a speech in October, Fed Gov. Frederic Mishkin said the Fed must have appropriate information about the institutions it lends to.
"The need to limit moral hazard by not lending to insolvent institutions indicates that central banks must have information sufficient to determine whether an institution with access to the discount window is indeed healthy," he said in a speech before the Museum of American Finance commemoration of the Panic of 1907. "That consideration is one reason that central banks benefit from having some supervisory responsibility for institutions with access to the discount window."
Some observers praised Mr. Paulson's speech, saying it reflected a growing consensus that more oversight is needed.
"It's a recognition now by the administration that there does have to be some kind of framework put in place to deal with these major financial crises that cut across many financial players," said Ron Glancz, a partner at Venable LLP. "We need something in place so you don't have to reinvent the wheel next time you have a major crisis."
But Wayne Abernathy, a former Treasury official and now executive vice president of financial institution policy at the American Bankers Association, disagreed, saying that the case had not been made that investment banks should be regulated in the same type of way as depository institutions. Fed regulation of investment banks would be a conflict of interest, he said.
"They could need to make monetary policy decisions that might harm the financial firms, and if they are the lead regulator of all financial firms, then they are between a rock and a hard place," he said.
"They should not be put in that kind of conflict because in the end they are the only ones that could do monetary policy."
Oliver Ireland, a partner at Morrison & Foerster LLP, said that regulation of investment banks has long been a topic in Washington but that recent events — most notably the collapse of Bear Stearns — have been a wake-up call. Mr. Paulson's suggestions regarding regulation will probably carry more weight, Mr. Ireland said, because he is a former chairman and chief executive officer of Goldman Sachs.
"You've got somebody who's been at the heart of the investment banking system, the wholesale financial markets, and ought to be familiar with their problems," he said, "and I think recognition at that level that the markets are changing and the regulation system needs to come up and change with them is helpful."
Still, though policymakers largely agree that investment banks will get more supervision in the long term, significant changes are unlikely in the near term due to a relatively short congressional calender and the presidential election, observers said.
The Treasury Department is working on a regulatory blueprint for the financial sector, and some saw the secretary's remarks on investment banks as clues to the direction of the blueprint, which is expected out soon.
"The whole model of investment bank regulation is based on an old broker-dealer rule," said Karen Shaw Petrou, managing director of Federal Financial Analytics. "It's based on the fact that, once, broker-dealers acted only as agents. Now they act as principals, and that is not reflected on any of the SEC's rules."
Mr. Paulson also used his speech to dismiss any wide-scale effort to address negative equity due to falling home prices.
"We do not need a systemwide solution for the vast majority of loans where a homeowner temporarily has negative equity," he said.
Observers were split on whether the comment signaled administration opposition to legislation from Sen. Dodd and Rep. Frank that would use the Federal Housing Administration to try to stabilize housing prices.
"I see him as criticizing the Frank-Dodd plan," said Brian Gardner, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc.
But Jennifer Zuccarelli, a Treasury spokeswoman, denied that the comment was aimed directly at Rep. Frank's plan.
Mr. Paulson also used the speech as an opportunity to defend the government's rescue of Bear Stearns.
"The Federal Reserve acted promptly to resolve the Bear Stearns situation and avoid a disorderly wind-down," he said. "It is the job of regulators to come together to address times such as this, and we did so. Our focus was the stability and orderliness of our financial markets."
