WASHINGTON (Reuters) - Treasury Secretary Henry Paulson said on Thursday the Federal Reserve should be given explicit authority to step in to protect the financial system if its stability is threatened, even if it means offering emergency funding to investment banks.
U.S. policy-makers have begun searching for agreement on new regulatory ground rules in the wake of the Fed’s March decision to throw an emergency-loan lifeline to investment banks for the first time since the Great Depression.
Paulson, Fed Vice Chairman Donald Kohn and Securities and Exchange Commission Chairman Christopher Cox all weighed in on Thursday about how best to devise a system that can adequately respond when a full-scale financial market meltdown threatens.
“It seems clear that in the future the central bank might need to make liquidity available to a broader range of financial institutions under certain extraordinary circumstances,” Paulson said as he urged quick action.
Separately, Kohn told a Senate hearing that the U.S. central bank was considering what to do when the Primary Dealer Credit Facility that it set up in March expires in September.
“We are looking at this issue right now and have a number of alternatives under consideration and we are talking about this within the Federal Reserve and I’m not prepared to say something right now,” Kohn said.
In an opinion piece in The Wall Street Journal, Cox raised the question of whether investment banks should be able to approach the Fed for emergency loans on a permanent basis, but he did not indicate a preference.
By law now, the Fed can only lend to nondepository firms in “unusual and exigent circumstances” — a clause it invoked as it set up its temporary program for investment bank lending and brokered a controversial bailout of Bear Stearns.
“In the long run, it will be up to Congress to make the fundamental policy choice of whether taxpayer-funded liquidity facilities should be made available to investment banks on a permanent basis,” Cox said.
In general, the officials agreed the Fed should get special supervisory authority and they appeared to be searching for a way to ensure that emergency funding in some form will be available once the Fed’s emergency backup expires.
“We should quickly consider how to most appropriately give the Fed the authority to access necessary information from highly complex financial institutions and the responsibility to intervene in order to protect the system, so they can carry out the role our nation has come to expect — stabilizing the overall system when it is threatened,” Paulson said.
He conceded to a questioner that it was unlikely Congress would approve proposals this year to boost Fed oversight of markets, but he insisted speed was important.
The Fed and the SEC have nearly completed a formal agreement on how they will share responsibility for overseeing the financial system as an interim measure until it is decided whether the Fed gets a new role as a kind of super regulator.
Currently, the Fed formally regulates only commercial banks, while the SEC has responsibility over investment firms.
The Fed has faced a storm of criticism, but also some praise, for its role in the Bear Stearns rescue.
The Fed was credited with helping ward off a market meltdown, but its actions also raised worries that investment banks might be less careful in taking risks in the future because they would count on a bailout.
Policy-makers now are striving to find a balance between making funds too readily available and ensuring the financial system has some form of protection when large financial firms are faltering.
“We must limit the perception that some institutions are either too big or too interconnected to fail,” Paulson said. “If we are to do that credibly, we must address the reality that some are.”
Reporting by Glenn Somerville; Editing by Diane Craft