“This latest episode has highlighted that the world has changed as has the role of other nonbank financial institutions and the interconnectedness among all financial institutions,” Paulson said. “These changes require us all to think more broadly about the regulatory and supervisory framework that is consistent with the promotion and maintenance of financial stability,” he added.
In extraordinary actions aimed at preventing a meltdown of the U.S. financial system, the Federal Reserve recently backed JP Morgan’s takeover of Bear Stearns and agreed to provide an important multibillion dollar financial lifeline for the deal. In addition, the Fed, in the broadest use of its lending authority since the 1930s, said it would let squeezed Wall Street investment houses go directly to the Fed for emergency loans. That has long been a privilege just for commercial banks.
Paulson said he “fully supported that action” but said it also raises important policy considerations about the oversight of investment houses.
The secretary said that commercial banks’ access to the Fed’s emergency lending “discount window” has traditionally been accompanied by regulatory oversight and supervision. “Certainly any regular access to the discount window should involve the same type of regulation and supervision,” Paulson said, in an apparent reference to the Fed’s temporary extension of this emergency lending to investment houses.
And he suggested that the Fed collect as much information as necessary on investment houses to “make informed lending decisions.” He said the Fed is currently working to do that. Paulson suggested the Fed, the Securities and Exchange Commission and the Commodity Futures Trading Commission also continue to work to build a framework on this.
“The combination of these steps should provide the Federal Reserve with a structure and the information that it would need to make liquidity backstop loans during periods of market instability to nonbanks,” Paulson said.
These steps, he said, “would enable the Federal Reserve to protect its balance sheet, and ultimately protect U.S. taxpayers,” he said.
Although he praised the Fed’s decision to temporarily provide an short-term loans to investment houses, Paulson 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.”
At this time, the Fed’s action “should be viewed as a precedent only for unusual periods of turmoil,” Paulson said.
Fielding questions after his speech, Paulson said that “innovation always precedes regulation in our economy” and suggested that oversight needed to catch up.
Once again Paulson defended the government’s role in coming to the aid of Bear Stearns - which has been criticized by some Democrats and others as akin to a federal bailout.
“Bear Stearns found itself facing bankruptcy,” Paulson said. “The Federal Reserve acted promptly to resolve the Bear Stearns situation and avoid a disorderly wind-down. 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.”
Paulson said the administration will explore ways to help struggling homeowners at risk of losing their homes. But he was cool to some of the proposals put forth by Democrats on Capitol Hill, saying that “most are not yet ready for the starting gate.”
In addition, he rejected the need for a “systemwide solution” to deal with homeowners who have no equity in their home. That’s when one’s mortgage eclipses the value of their home.
Fed Chairman Ben Bernanke recently urged lenders to help distressed homeowners by lowering the amount of their loans. He offered this because so many homeowners have little or no equity in their homes, giving them little financial incentives to stay in them.
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