(Adds Levitt, Casey, Ludwig comments, background, byline)
By Karey Wutkowski
WASHINGTON, Oct 16 (Reuters) - The U.S. Securities and Exchange Commission should get more power to police credit derivatives even though it failed to use its existing authority to rein in risky behavior that contributed to a global financial crisis, a former SEC chief told Congress on Thursday.
Arthur Levitt, chairman of the SEC from 1993 to 2001, harshly criticized his former agency for falling down on the job in recent years.
“As the markets needed more transparency, the SEC allowed opacity to reign,” Levitt said in prepared testimony for a Senate Banking Committee hearing. “As an overheated market needed a strong referee to rein in dangerously risky behavior, the commission too often remained on the sidelines.
However, the agency is the best-placed regulator to crack down on credit derivatives, credit rating agencies, investment banks and municipal markets, Levitt said, and should have more authority in those areas.
Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said regulators, including the Federal Reserve, failed to adequately police the mortgage lending markets.
“Our nation’s financial regulators willfully ignored abuses taking place on their beat, choosing to embrace the same faulty assumptions that fueled the excessive risk-taking in the marketplace,” Dodd said.
The panel discussion on Thursday is part of a series of hearings lawmakers will be holding to analyze the causes of the economic turmoil and the regulatory reforms that should take place.
The hearings come on the heels of a $700 billion bailout plan Congress passed earlier this month. The rescue plan allows the Treasury Department to directly inject capital into banks and to buy up distressed assets weighing down financial firms’ books following the housing slump and resulting credit freeze.
Some lawmakers voiced concerns that policymakers are not doing enough to stem foreclosures.
Sen. Robert Casey, a Pennsylvania Democrat, said Treasury’s shift to more quickly inject capital into banks instead of buying up banks’ troubled mortgage assets and loans is having ill effects. “Banks are now holding back on modifying loans because they’re waiting to see if they can sell them to Treasury first,” Casey said. “Treasury needs to work more quickly to fully explain their plans to the American people and to the players in the marketplace.”
The panel of former regulatory officials and policymakers liberally placed blame on the SEC, the Fed and Bush administration officials for not supervising mortgage lenders and financial markets as financial services firms quickly developed complicated new products that widely spread risk.
There was disagreement, however, on the role of fair value, or mark-to-market, accounting.
Eugene Ludwig, chief executive of the Promontory Financial Group and former comptroller of the currency, said the accounting standard has “clearly added to the financial catastrophe” and must be materially reworked.
Fair value accounting took full effect this year in the United States and was designed to let investors truly see what is on the balance sheet and to help them understand which assets are under stress.
But the shift to current market values, as opposed to historical values, has led financial services firms to make stunning write-downs as they realize the devastating impact of a housing slump and sluggish economy on mortgage-related holdings.
Some have called on regulators to suspend fair value accounting to provide relief to the banking sector.
Levitt, however, said fair value accounting should be expanded. “One of the biggest steps we can take to bring to light a fuller picture of companies’ financial health would be to expand fair-value accounting to cover all of the financial instruments - the securities positions and loan commitments — of all financial institutions,” he said.
Looking forward, Ludwig said financial regulation must be streamlined among agencies. He also said universities should create more courses and degrees for financial services supervision and regulation. Finally, he said the financial system should be deleveraged to contain asset price bubbles.
Levitt said the SEC could be improved by giving it $85 million to rebuild its staffing, by adding investor advocates to the five-member commission, and by enhancing its responsibilities to police financial markets.
“But let me be clear: a restoration of the SEC to its position from before this current slide is not enough,” Levitt said. “At this moment, we need a dramatic rethinking of our financial regulatory architecture — the biggest since the New Deal.” (Reporting by Karey Wutkowski; Editing by Brian Moss and Gunna Dickson)