Federal Reserve Chairman Ben Bernanke called on Congress Tuesday to write new laws that would expand the Fed's role in preventing financial crises, such as the collapse of Bear Stearns last March.
"The financial turmoil is ongoing, and our efforts today are concentrated on helping the financial system return to more normal functioning," Bernanke told a mortgage-lending forum in Arlington, Va. "It is not too soon, however, to begin to think about the steps we might take to reduce the incidence and severity of future crises."
Bernanke also announced that the Fed may keep its so-called discount lending window open to big investment banks and brokerage houses through at least the end of the year. The window essentially extends credit to big financial institutions, as a way of keeping them operating during crises and restoring confidence in the nation's financial system.
The Fed decided to begin extending credit to such institutions, even though they're not regulated by the agency, during the Bear Stearns crisis. The window was supposed to stay open through September, but with the continuing turmoil in the credit markets, fed officials have decided they may keep it open longer.
Bernanke said the Fed has also been working with the U.S. Securities and Exchange Commission to strengthen capital positions, liquidity reserves and risk-management practices at the banks it regulates. But many big financial institutions, such as investment banks, fall outside its jurisdiction.
Congress needs to expand the Fed's role and "task the Fed with promoting the overall stability of the financial markets," Bernanke said. For instance, the Fed should be given the authority to examine the books at financial institutions on the verge of financial collapse, to better understand the extent of their liabilities. It should also be given more tools to stabilize the markets when necessary, such as establishing bridge financing for insolvent banks.
These changes represent a huge potential transformation in the Fed's role.
"I think he was outlining both some immediate changes that would be very dramatic and, down the road, an even more profound restructuring of the U.S. financial system," said Karen Shaw Petrou, managing director of the research firm Federal Financial Analytics.
The financial markets are so anxious right now that almost anything can shake investor confidence, Petrou said. A single analyst report suggesting that Fannie Mae and Freddie Mac may face capital problems sent shares of the two companies plummeting on Monday. They rebounded somewhat on Tuesday after government regulators said the fears were overblown, but Petrou says there's a lesson in what happened.
"The financial markets remain extremely troubled, and none of the immediate regulatory fixes is sufficient to reduce the systemic risk posed right now," she said.
The speech by Bernanke came at a time when the Bush administration is wrestling with the question of how to respond to the nation's many economic troubles. Vince Reinhardt, a former Fed economist now with the American Enterprise Institute, worries that regulators may overplay their hand, imposing new laws that stifle the banking sector.
"We need more governance of the financial system," Reinhardt said. "That's a lesson of the last year and a half. Nobody would disagree with that. The question is, 'Are we going to do it right, or are we going to be heavy-handed in it?'"
Bernanke also announced that the Fed would release new rules next week aimed at protecting homebuyers from unscrupulous lending practices.
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