With increased regulation looming Fed chief talks of risk management

Though calm seems to have returned to credit markets roiled by nine months of financial turbulence, the expectation remains for the increasingly activist Federal Reserve to increase its patrols of the financial system.

Fed Chairman Ben Bernanke spoke Thursday in Chicago about the origins of the credit turmoil, which he traced to a series of institutional risk management failures. Bernanke was the keynote speaker at the 44th Annual Conference on Bank Structure and Competition at the Hotel Intercontinental.

“Problems occurred at each step of the credit-extension chain,” Bernanke said. His remarks pointed specifically at the loan originators who applied loose standards and sparked the subprime mortgage crisis that eventually enveloped the world’s financial markets.

Bernanke’s speech came at a time when proposals are being considered that would give the Fed sweeping new powers to oversee the nation’s financial system.

In March, Treasury Secretary Henry Paulson unveiled his “blueprint” for a financial regulatory overhaul. The plan proposed giving the Fed broad, loosely defined responsibility for financial system stability.

But not everyone thinks a bigger Fed and more regulation is a good thing.

“I think we have too much regulation already,” said Daniel J. Mitchell, senior fellow at the Washington D.C-based Cato Institute.

“There always should be laws against fraud and things like that,” Mitchell went on. “But the notion that some bureaucrat is going to know the right way to access risk … the government’s not well suited to play that role.”

There is controversy over the benefits of increased corporate regulation. Some say the Sarbanes-Oxley Act, enacted in 2002 in response to accounting scandals made famous by Enron Corp. and Worldcom Inc., has hindered the economy.

“It’s been effective at driving companies out of the U.S. and making U.S. companies less effective,” said Mitchell at the Cato Institute.

The average cost of Sarbanes-Oxley compliance in 2006 was $2.8 million for companies with less than $1 billion in annual sales, according to a 2007 survey by law firm Foley & Lardner LLP. While costs have leveled out in recent years, the report indicated that between 2001 and 2006 Sarbanes-Oxley costs increased 171 percent.

The study also reported that nearly one in four survey respondents were considering going private because of corporate governance and public disclosure reforms.

Nevertheless, members of Congress are clamoring for more financial oversight in the wake of the housing and subprime crises.

During his testimony before the Joint Economic Committee of Congress on Wednesday, former Fed Chairman Paul Volcker chastised the Fed and other regulators for allowing banks to have unregulated off-balance-sheet commitments.

Volcker called for a bigger, better paid Fed staff to help it keep up with its regulatory duties, but he pondered how much the Fed could be expected to supervise.

"Just how far should the logic of regulation and supervision be extended?” Volcker asked in his testimony. He also questioned whether Fed oversight of investment banks could lead to regulatory responsibility for hedge funds.

Perhaps, however, the Fed has earned some credibility during the crisis, as fear and panic in the markets seem to have retreated in recent weeks.

Credit markets have shown signs of stability after the Fed’s initiatives to accept wider ranges of collateral, extending credit to non-banks and looking into their books, as well as making a $29 billion loan to J.P. Morgan Chase and Co to prevent the collapse of Bear Stearns Co.

In August the spread between the risk-free 3-month Treasury interest rate and the 3-month Eurodollar rate widened, indicating fear in the market during the first credit panic over subprime mortgage losses.

Fear has since forced the spread wider on four occasions, with the widest recent spread at 204 basis points on March 19 after the near collapse of Bear Stearns. Recently the spread has narrowed, falling this week to as low as 86 basis points according to Bloomberg data.

“We are not healed until that comes in well below 100 basis points,” said Ken Mayland, president of ClearView Economics LLC.

The changing regulatory role of the Fed is not just a concern for public companies, but for investors as well.

To help clients stay informed, Itasca-based wealth management firm Balasa Dinverno and Foltz LLC brought Gregory R. Valliere, chief political strategist for the Washington Research Group, to speak last week.

Valliere told the audience to expect a “dramatic expansion of the role of government in response to subprime.” He said that while the entire government will get bigger, financial regulation will balloon the most.

However, after his presentation Valliere noted that Treasury Secretary Paulson’s blueprint probably won’t become the model for the U.S. financial system.

“The overwhelming expectation is that it will get rewritten,” Valliere stated. He said he expects Congressman Barney Frank, D-Mass., chairman of the House Finance Committee, will be the one who ultimately prepares the regulation.

“Paulson just shifted responsibility, he didn’t toughen the regulations. That’s got to be added,” Valliere said.

For its part, Congressman Frank’s office, which has been fighting with President Bush over legislation to provide relief for some homeowners facing foreclosure, said it is prepared to look into greater federal financial oversight.

“Obviously we have a serious lack of regulation in the home mortgage market,” said a spokesman for Congressman Frank.

“We need to take a long examination into the issues around the collapse of Bear Stearns and the environment of systemic risk, how large institutions impact the overall economy,” the spokesman said.

http://news.medill.northwestern.edu/chicago/news.aspx?id=89391

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With increased regulation looming Fed chief talks of risk management