Thursday, June 19, 2008

Paulson Calls for Clear Procedures to Shut Down Failing Investment Banks

Paulson Urges Clear Process to Close Investment Banks

By Rebecca Christie

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U.S. Treasury Secretary Henry Paulson joined Federal Deposit Insurance Corp. Chairman Sheila Bair in calling for bank regulators to have clear procedures for dealing with a failing investment bank.

Paulson said it needs to be clear what happens to financial firms that aren't part of the commercial banking system and don't have access to the same safety net. The Treasury chief also reiterated in a speech in Washington today that the U.S. economy is in a ‘‘rough period'' and that rising energy prices may prolong the slowdown.

Regulators are seeking to contain the danger that firms will make riskier bets in the aftermath of the Fed's rescue of Bear Stearns Cos. and introduction of direct loans to investment banks. Paulson said market ‘‘discipline'' must be strengthened, with firms not expecting that central bank aid will be ‘‘readily available.''

‘‘There still seems to be uncertainty surrounding the process by which a large complex institution is wound down and what impact it would have on the overall financial system,'' Paulson said. Regulators should determine whether to assign a specific agency to oversee resolutions, he said.

Bair Proposal

Bair, whose agency insures deposits at 8,534 commercial banks, told reporters yesterday the FDIC ‘‘would not turn it down'' if Congress gave it the authority to shut down failing investment banks. She said last month the FDIC's authority to set up bridge banks to take over and sell assets of failed banks offered a ‘‘good model'' for what's needed for investment banks.

Responding to questions after his speech, Paulson said Bair's idea for a resolution plan for troubled financial firms was ‘‘dead on.''

‘‘We must limit the perception that some institutions are either too big or too interconnected to fail,'' Paulson said at the Women in Housing and Finance annual luncheon. ‘‘If we are to do that credibly, we must address the reality that some are.''

Securities and Exchange Commission Chairman Christopher Cox indicated his agency warrants additional authority over investment banks, in an opinion piece in the Wall Street Journal today. It's ‘‘vital'' for Congress to give authorization for the SEC's current voluntary program of supervising securities' firms capital and leverage ratios, he wrote.

Paulson said the Fed's role should be broadened, repeating his call in a March ‘‘blueprint'' for a regulatory overhaul.

Fed's Role

‘‘Our nation has come to expect the Federal Reserve to step in to avert events that pose unacceptable systemic risk. But, as we noted in our Blueprint, the IND' ))">Fed has neither the clear statutory authority nor the mandate to anticipate and deal with risks across our entire financial system,'' Paulson said.

As an interim step, the Fed and Securities and Exchange Commission are discussing a ‘‘memorandum of understanding'' to address what information and access the central bank needs in return for loans to investment banks.

Paulson, Cox and Fed Chairman Ben S. Bernanke and their staffs are in almost daily discussions about the future of the so-called Primary Dealer Credit Facility, according to an official who spoke 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.

Derivatives Markets

Paulson also today called for improvements in the derivatives and repurchase markets to prevent bottlenecks that could roil the financial system.

‘‘Given the massive scale of the over-the-counter derivatives market, we need to enhance trade processing with more automation, clear the backlog and create utilities and protocols that will make the process more efficient,'' Paulson said.

Repos are one of Wall Street's main financing channels. The Fed uses repos for its open market operations to keep the rate on overnight loans between banks close to the target set by policy makers.

The Treasury chief said ‘‘we must address risks associated with a potential counterparty failure and the risk associated with the potential disruption of a clearing bank'' in the repo market.

Paulson said he was ‘‘very hopeful'' that Congress would pass legislation to strengthen the regulation of government- chartered companies including Fannie Mae and Freddie Mac, the two largest sources of U.S. house financing. Still, some of the provisions in the Senate's version of the housing bill are ‘‘objectionable,'' he said.

-- With reporting by Craig Torres and Jesse Westbrook. Editors: Chris Anstey, Brendan Murray

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