U.S. Needs Financial Regulatory Overhaul: Officials

WASHINGTON(Reuters) – U.S. policy-makers said on Thursday they were doingeverything possible to restore calm to financial markets but toldlawmakers a longer-term regulatory overhaul was vital to prevent crisesin the future.

Federal Reserve Chairman Ben Bernanke and Treasury Secretary HenryPaulson told Congress the Fed should get a stronger hand in supervisinginvestment banks to help shield the broader economy from problems likethe ones that forced the emergency rescue of investment bank BearStearns.

"The Bear Stearns episode and market turmoil more generally haveplaced in stark relief the outdated nature of our financial regulatorysystem, and has convinced me that we must move much more quickly toupdate our regulatory structure and improve both market oversight andmarket discipline," Paulson told Congress.

"We should consider how to most appropriately give the FederalReserve the authority to access necessary information from complexfinancial institutions … and the tools to intervene to mitigatesystemic risk in advance of a crisis," he said.

Bernanke, in testimony before the same House Financial Serviceshearing, said authorities are working within their existing authorityto settle markets roiled by a credit crunch.

He also recommended stricter oversight of large investment banks andprimary dealers that trade securities directly with the Fed in light ofthe disruptions that have battered the U.S. economy.

"Cooperation between the Fed and the (Securities and ExchangeCommission) is taking place within the existing statutory frameworkwith the objective of addressing the near-term situation," Bernankesaid in comments that echoed a speech he gave on Tuesday.

"In the longer term, however, legislation may be needed to provide amore robust framework for the prudential supervision of investmentbanks and other large securities dealers," he said.

ELECTIONS A HURDLE

Both policy-makers agreed that, with presidential elections on thehorizon, it was unlikely that regulatory reforms could be pushedthrough this year but vowed to continue looking for solutions torestore market stability.

Paulson said regulators need emergency authority to step in to limit temporary disruptions to financial markets.

"These authorities should be flexible, and — to reinforce marketdiscipline — the trigger for invoking such authority should be veryhigh, such as a bankruptcy filing," Paulson said.

"Any potential commitment of government support should be anextraordinary event that requires the engagement of the TreasuryDepartment and contains sufficient criteria to prevent costs to thetaxpayer to the greatest extent possible," he added.

Paulson also said that Fannie Mae and Freddie Mac — the nation’stop two providers of housing finance, which have come under toughscrutiny amid the subprime mortgage lending crisis — play a vital roleand should continue to do so. The stock prices of the twogovernment-sponsored mortgage finance enterprises have been pummeled inrecent days — and were again on Thursday — because of speculationthey face financial difficulties, and could even be in need of agovernment bailout.

"Their regulator has made clear that they are adequately capitalized," Paulson said.

Separately, the presumptive Republican nominee for president, Sen. John McCain, said the government could not allow Fannie Mae and Freddie Mac to fail in a crisis.

EFFORTS TO REGAIN FINANCIAL SYSTEM’S STABILITY

Bernanke said market turbulence continues and that governmentofficials are focused on helping the financial system regain stability.

"The financial turmoil is ongoing, and our efforts today areconcentrated on helping the financial system return to more normalfunctioning," he said.

Paulson, in discussing regulatory reforms and the need to overhaulthe financial regulatory system, argued that it was vital to maintainmarket discipline as a guiding force.

"Regulation alone cannot eliminate all future bouts of instability,"Paulson said. He added that market participants should not count ongetting lending from the Fed or any other government support easily.

"For market discipline to effectively constrain risk, financial institutions must be allowed to fail," Paulson said.

(Additional reporting by Patrick Rucker; Editing by Leslie Adler)