New rules would help Wall Street: Obama adviser

WASHINGTON (Reuters) - Barack Obama sees an overhaul of Wall Street regulations as crucial to restoring trust in U.S. markets and could move early on it if he wins the White House, according to a senior adviser.

The housing-market meltdown and credit crisis that have pushed the U.S. economy to the brink of a recession have fostered debate in Washington over how U.S. regulations could be revamped to head off future crises.

Some in the industry warn that too strict a regulatory structure would stifle innovation and cause a shifting of activity to overseas markets.

But Austan Goolsbee, a top economic adviser to Democratic White House hopeful Obama, told Reuters in an interview that a proper balance can be found and a sensible plan would help markets function more smoothly.

"If anything, it undermines the innovations when (financial market players) are operating in a totally Wild West environment," said Goolsbee, an economist at the University of Chicago. "We've seen again and again, when you lose public trust, it's extremely difficult to re-establish it."

A top issue in the debate is the role the Federal Reserve, the Securities and Exchange Commission and other regulatory agencies in policing markets.

The Fed is in the spotlight after it came to the rescue of investment bank Bear Stearns in March and offered a lifeline in July to mortgage giants Fannie Mae and Freddie Mac.

A plan unveiled in March by the Bush administration would expand the Fed's power to monitor financial institutions.

Key lawmakers in the Democratic-led Congress have made clear they believe the issue of a regulatory overhaul should wait until after President George W. Bush's successor takes office in January.

Obama, an Illinois senator running against Republican John McCain in the November 4 election, has given two major speeches on financial regulation in New York over the past year.

Goolsbee said the decision to give the speeches showed the candidate's interest in the issue. Asked how quickly Obama could begin on an overhaul plan, he said, "It could be early."

Commercial banks have long had access to emergency credit through the Fed's discount window. But in exchange they must maintain reserves, known as capital requirements, and submit to stricter oversight than investment banks and other players.

"MORAL HAZARD"

The Bear Stearns bailout has sparked concern about "moral hazard" -- the idea that such rescues may encourage financial players to take on bigger risks on the belief they would be bailed out if their bets go wrong. That would put U.S. taxpayers on the hook for billions of dollars.

"We have seen that in a moment of crisis, institutions that never anticipated being able to access the discount window -- like investment banks -- have been given access," Goolsbee said. "Their behavior has not been subject to the kind of oversight required to protect taxpayers from these institutions taking excessive risks with, ultimately, the American people's money."

When it comes to the details of a regulatory overhaul, Goolsbee agreed on some points with Bush's Treasury Secretary Henry Paulson but disagreed on others.

Both believe "we ought to regulate the financial institutions by what they're doing rather than by who they are," he said.

But Goolsbee said much of the Treasury report is anachronistic "with far too little attention paid to the issues raised by the Bear Stearns rescue and the current financial crisis."

He said Paulson was unrealistic to suggest closer oversight of investment banks need not be permanent if they have access to the discount window only for a limited period.

"Even hardened free-market types know that you cannot set up a situation where we know that if everything truly goes wrong, we will once again open the discount window but not keep an eye on your behavior in the run-up to that time," he said.

"Access to the discount window is by its nature temporary. You only do it when everything else goes wrong and it's a last resort," he said.

Goolsbee also criticized the Treasury report's suggestion of delegating to the industry some regulatory powers now handled by the SEC and CFTC. "The administration's efforts to, in some way, reduce the strength of the regulators to fight deceptive practices or market manipulation is especially strange given recent events," he said.

(Reporting by Caren Bohan, Editing by Anthony Boadle)