U.S. regulators are planning how to let investment banks retain access to Federal Reserve loans if the central bank shuts an emergency program in September, two government officials said.
Federal Reserve Chairman Ben S. Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox and their staffs are in almost daily discussions about the future of the so-called Primary Dealer Credit Facility, said one of the officials on condition of anonymity.
The Treasury and SEC want the program, designed to be in place until at least September, to be temporary. The discussions with the Fed center in part on what precautions might need to be in place in case a large securities company with hundreds of trading counterparties faces failure, as was the case with Bear Stearns Cos.
At the same time, any new rules would need to deter firms from becoming too dependent on Fed loans, addressing concerns that such aid might lead to more reckless lending and future financial crises.
``The question is: What is the appropriate quid-pro-quo for allowing access'' to the Fed, said Robert Eisenbeis, former head of research at the Atlanta Fed and now chief monetary economist at Cumberland Advisors Inc., a Vineland, New Jersey, investment firm. ``If the Fed is on the hook, they should have the responsibility'' to dictate capital and leverage ratios, he said.
Scope of Aid
Paulson today said it's ``imperative that market participants not have the expectations that lending from the Fed is readily available.'' He repeated his view, in a speech in Washington, that the Fed's powers should be expanded so it gets needed information from financial firms beyond commercial banks.
``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.''
The central bank said in March the PDCF would be in place ``for at least six months.'' By statute, the Fed can only lend to nonbanks in ``unusual and exigent circumstances.''
The Fed introduced the program March 16, the same day it agreed to lend against $30 billion of Bear Stearns collateral to secure its takeover by JPMorgan Chase & Co. Firms can borrow at the same rate as commercial banks, which are already subject to capital rules and direct oversight by the Fed.
Shutting Firms
The supervisors are discussing measures that can be implemented without action by Congress. One aspect -- setting up a mechanism to shut a failing firm in an orderly manner -- would probably require legislation.
Lawmakers plan hearings to consider measures strengthening oversight of investment banks. Senator Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee, is skeptical of giving the Fed more powers.
Shelby ``believes the Congress should carefully consider whether an expansion of the Fed's authority is desirable,'' said Jonathan Graffeo, his spokesman.
Regulators haven't decided whether the Fed or SEC should be the main agency with power over capital and leverage, one official said. While the SEC has authority now, the arrangement failed to prevent the near-collapse of Bear Stearns in March.
Fed Deployment
Cox says the SEC succeeded in protecting Bear Stearns's clients. The Fed sent its own representatives to investment banks to monitor them after opening the PDCF.
Goldman Sachs Group Inc., Lehman Brothers Holdings Inc.,Merrill Lynch & Co. and Morgan Stanley now voluntarily submit their capital and liquidity positions to the SEC. The agency can restrict the firms' broker-dealer operations if they refuse to raise money or reduce leverage at its urging.
``The provision of backstop liquidity to the major investment banks has unavoidably reduced the penalties they face for taking on excessive risk,'' Cox wrote in an opinion piece in the Wall Street Journal today. ``Explicit legislative authorization for what is now a purely voluntary program of SEC supervision is vital.''
Some current and former Fed officials criticized the Fed's lending to Wall Street for creating moral hazard, or encouraging firms to take on more risk in anticipation of a rescue if their bets go wrong.
`Costly' Failure
Richmond Fed President Jeffrey Lacker urged that the central bank ``clearly'' set boundaries for its assistance. He warned in a June 4 interview that even new limits may not be believed by investors unless a financial firm fails ``in a costly way.''
``We run the risk of sowing the seeds of the next crisis,'' Philadelphia Fed President Charles Plosser told reporters after a June 5 speech in New York.
Investment banks had $8.4 billion of Fed loans outstanding on average in the week that ended June 11, down from a peak of $38.1 billion in April, the central bank's data show.
The Fed also started a $200 billion program for lending Treasuries to bond dealers. In December, officials introduced cash auctions to commercial banks to help ease funding strains.
``These facilities have played a significant role in easing liquidity strains in markets and we plan to leave them in place until conditions in money and credit markets have improved substantially,'' New York Fed President Timothy Geithner said in a June 9 speech.
Geithner, who spearheaded the Bear Stearns rescue, urged a regulatory overhaul so that one supervisor oversees the liquidity and capital of both commercial and investment banks.
``Either they will have to close the access and lock the door and throw away the key, or they will have to change the structure'' of supervision, said Edwin Truman, a former Treasury assistant secretary who is now a senior fellow at the Peterson Institute for International Economics in Washington. ``There is room for many views.''
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