Bernanke at Fed Meeting: More Banking Oversight Needed

The ongoing financial crisis, which has run for more than 18 months, shows the need for revamped banking oversight, Federal Reserve Chairman Ben Bernanke told bankers Thursday at the Federal Reserve Bank of Chicago’s annual conference on bank structure and competition. Others at the meeting suggested making Fannie Mae and Freddie Mac fully government-owned companies.

“We have been closely monitoring [financial] firms’ capital levels relative to their risk exposures and discussing our evaluations with senior management,” Bernanke said. “We have also been revising our policies on capital.”

Earlier in the year, the Fed issued new supervisory guidelines on dividends, capital repurchases and capital redemptions, re-emphasizing that holding companies must serve as a source of strength for their subsidiary banks.

“The events of the past two years have revealed weaknesses in both private sector risk management and in the public sector’s oversight of the system,” Bernanke said. “It is imperative that we apply the lessons of this experience to strengthen our regulatory system, both at the level of its overall architecture and its daily execution.”

However, capital isn’t the only issue regulators are addressing, Bernanke said. “The crisis has also demonstrated the importance of effective liquidity management. We are monitoring the major firms’ liquidity positions on a daily basis and are discussing liquidity strategies, key market developments and liquidity risks with the firms’ senior managements. Adequate liquidity management entails more than holding assets that are liquid in normal times. Firms must take into account how their liquidity positions might fare under stressed market conditions. We are also requiring firms to consider risks arising from the need to fund off-balance sheet positions.

“Although current reform of the system is necessary, much can be done within the current framework,” Bernanke added. “The Federal Reserve has engaged in extensive introspection and review of the lessons of the crisis and is working diligently to implement was has been learned. As the past two years have brought home to everyone, the development of a more stable and a more sound financial system should be of the highest priority.”

In a subsequent session, Diane Casey-Landry, senior executive ice president of the American Bankers Association, called for Fannie Mae and Freddie Mac to emerge from conservatorship. “These agencies are important to home ownership andc the banks that make the mortgage loans. Their role in providing a secondary mortgage market needs to be clarified within the broader context of the new regulatory structure.”

But Thomas Stanton, a fellow with the Center for the Study of American Government at Johns Hopkins University, said that the government should place Fannie Mae and Freddie Mac into receivership and allow them to function as wholly owned government corporations to support the mortgage market.

“For many reasons, the GSE [government-sponsored enterprise] has outlived its usefulness as an organizational form,” Stanton said. “The GSEs squandered a policy tool that the government had used for decades: the perception of an implicit rather than an explicit federal guarantee of their debt obligations. That means that the government would have to provide some type of explicit guarantee if the GSEs were to be restored.”

Casey-Landry also called for the winding down of federal home mortgage modification programs as well as the closure of gaps in regulation.

“A major cause of our current problems is the regulatory gaps that allowed some entities to completely escape effective regulation,” Casey-Landry said. “It is now apparent to everyone that a critical gap occurred with respect to the regulation of independent mortgage brokers. Questions are also being raised with respect to credit derivatives, hedge funds and others.”

However, she cautioned: “Congress should be careful not to impose new, unnecessary regulations on the traditional banking sector, which was not the source of the crisis and continues to provide credit.”