Could it be that a turf war is breaking out? In testimony before Congress Thursday morning, Securities and Exchange Commission Chairman Christopher Cox asked legislators to give the SEC authority to regulate investment banks. In the same session, New York Federal Reserve Bank President Timothy Geithner said the Fed needs to have regulatory authority over any institutions it provides with funding.
In the wake of the sub-prime crisis and near-collapse of Bear Stearns in mid-March, regulatory reform for investment banks has become a popular topic in Washington and on Wall Street. There has been some speculation that the Federal Reserve would begin to regulate investment banks much in the same way that it regulates commercial banks today, requiring them to compute capital requirements and maintain liquidity levels on a consolidated basis, and discouraging certain kinds of financial risk-taking. Cox said in his testimony that he thought this would be a really bad idea.
Edward A. H. Siedle, president of the Center for Investment Management Investigations, and formerly on the staff of the SEC, agrees. "I would agree with that, not giving up authority to Fed," says Siedle. "The SEC has knowledge of the investment banking and securities industry that bank regulators just don’t have. Whether they are effectively flexing that muscle and putting that power to work is another matter. But the agency is certainly capable. It has often demonstrated that, not always, but often."
Both Cox and Geithner delivered their remarks before the House Financial Services Committee.
In his testimony, Cox also requested guidance on how to handle and fund future financial crises like the one that brought Bear Stearns to its knees. And he asked that any legislative reforms not allow the Federal Reserve to provide emergency funding to investment banks—except in extraordinary cases. After the Bear Stearns episode, the Federal Reserve made temporary funding available to investment banks through discount window borrowings, something that had only been available to commercial banks.
"It is conceivable that Congress could create a framework for investment banking that would intentionally discourage risk taking, reduce leverage and restrict lines of business, but this would fundamentally alter the role that investment banks play" in the U.S. and abroad, Cox said. If this were to happen, he said, hedge funds would simply step in and take over the “high-risk functions” that the investment banks now play.
Today the SEC only regulates the brokerage activities of investment banks. But Cox said Congress should give the SEC authority to set standards for capital, liquidity, recordkeeping, reporting, risk management and internal controls. He also suggested that the SEC should be allowed to “apply progressively more significant restrictions on operations” if capital or liquidity levels get too low, even forcing divestiture of certain businesses. Finally, Cox said that if Congress decides that certain banks are too big to fail, it should limit any changes it makes to the bankruptcy rules for these institutions.
The two regulators are not working at cross-purposes, in any case. Earlier this month, the Federal Reserve and the SEC signed a memorandum of understanding (MOU) to increase information sharing and cooperation concerning bank holding companies and investment banks.