WASHINGTON - As federal regulators continue to unveil new measures
to reverse the global financial crisis, Congress on Tuesday began
weighing what changes might be needed to restore confidence in the U.S.
financial system and prevent future crises.
The House Financial Services Committee, which will be instrumental in
drafting any regulatory changes, heard testimony from academic and
industry experts who agreed on the need for new regulation, the merging
of some regulatory agencies and writing rules to govern complex
must decide whether to start by patching holes on a leaking ship,
taking a piecemeal approach, or to prepare broad legislation that
amounts to building a new ship.
Stiglitz, a Columbia University professor and the 2001 recipient of the
Nobel Prize in Economics, warned the committee that waiting on reform
amounts would delay efforts to restore confidence in the U.S. financial
"We know the boat has a faulty steering mechanism and is
being steered by captains who do not know how to steer, least of all in
these stormy waters," Stiglitz said, in a stinging criticism of Wall
Street executives. "Unless we fix both, there is a risk that the boat
will go crashing on some other rocky shoals before reaching port."
area of seemingly unanimous agreement Tuesday was to empower the
Federal Reserve to guard against threats to the U.S. financial system.
the crisis, the Fed has acted as the top regulatory cop, but in many
areas it lacks sufficient authority. Fed Chairman Ben Bernanke said in
a speech last week that he was powerless to prevent the bankruptcy of
investment bank Lehman Brothers because of his limitations under
The Fed has pushed the limits of its authority with
numerous creative steps to bolster markets since last March, when the
financial crisis began snowballing. These include lending to investment
banks, corporations and even foreign central banks, none directly under
its regulatory umbrella.
On Tuesday, the Fed unveiled another new
effort to restore confidence, this time shoring up the $1.7 trillion
money market mutual fund industry by agreeing to backstop as much as
$540 billion worth of lending.
The new Money Market Investor
Funding Facility will allow money market institutions to sell their
holdings of certificates of deposit and commercial paper, the
short-term promissory notes issued by U.S. corporations. Because the
credit markets have seized up, money market firms can't sell their
holdings. The Fed hopes that by purchasing these debt instruments, it
will unclog these markets and signal that they're safe.
on Tuesday appeared to agree on the need to reduce the number of
financial regulators and increase their scope. Among the possibilities
is merging the regulators of banks and thrifts into a single entity,
and merging the Securities and Exchange Commission with the Commodity
Futures Trading Commission to reflect that Wall Street now is deeply
entrenched in markets for a wide array of products other than stocks.
number of regulators should be less than we have now, we clearly have a
lot of duplication," said Alice Rivlin, a former Fed vice chairman and
now a researcher at The Brookings Institution, a public-policy
organization in Washington. "I do think we need a regulator of
financial behemoths, sometimes known as bank holding companies, that is
responsible for making sure they are adequately understanding and
monitoring their own risk."
Lawmakers also supported the creation
of a special select committee of Congress that could go beyond the
usual turf wars and determine what caused the financial crisis and
Broad membership on such a congressional
committee could bridge the current gaps that have resulted in the
agriculture committees, not finance panels, having jurisdiction over
the futures markets, where contracts for future deliveries of oil,
natural gas and farm products are sold.
Wall Street investment
banks, which fall under the finance committees, have pumped trillions
of dollars into commodities markets. Some critics charge that this
distorted these markets and pushed up the price of oil and a number of
farm products to record levels earlier this year.
There also was
unanimity behind bringing some minimum regulation to the
over-the-counter derivatives markets. These markets are vast and
"dark," or unregulated and non-transparent, for complex financial
instruments that billionaire investor Warren Buffett famously dubbed
"financial weapons of mass destruction."
These products derive
their value from the underlying value of another instrument.
Unregulated over-the-counter markets for derivatives, where
transactions are between private parties instead of on a regulated
exchange, are twice as large as the regulated markets are for them. In
the oil market, these insurance-like instruments are called
over-the-counter swaps. On products whose underlying value is derived
from some form of debt, they're called credit-default swaps.
swaps and derivatives were excluded from the last overhaul of commodity
trading rules in 2000, and credit-default swaps were prominent in
September's collapse of global insurer American International Group.
was the leading issuer of swaps, but after paying out more than $18
billion on bets against mortgage bonds, it lost the confidence of
investors. That prompted the Fed to step in with an $85 billion loan to
prevent the potential collapse of the unregulated swap system.
(swaps) are areas where a broader regulatory approach would have served
us well," Joel Seligman, the president of the University of Rochester
in New York and an expert in securities law, told the committee.
SEC and the CFTC are both vying for the right to regulate swaps. The
Federal Reserve Bank of New York also has been working with the
financial industry to create a transparent mechanism for settling
contracts between buyers and sellers of swaps.
coming months, as Washington tackles a regulatory overhaul of the
nation's financial markets, there will be lot of terminology thrown
around for complex financial instruments that to date largely have
escaped regulation. Here's a glossary of some of these terms.
Derivatives: Financial instruments that derive their value from the
underlying value of another instrument. Investors buy these to help
manage risk, often taking the opposite position in a derivative from
what they've taken in the underlying asset.
derivatives: These are regulated derivatives. One example is a futures
contract, which gives the buyer a right to purchase oil, corn or some
other commodity at a certain price at a future date.
Over-the-counter derivatives: These are traded in markets where there's
no government regulation and they're bought and sold through contracts
between parties. These markets have become bigger than stock or futures
- Over-the-counter swaps: OTC swaps are instruments in
which an investor enters into a deal to purchase oil contracts at a
specified price from the swap dealer over a fixed period of time. If
oil rises above this price, the swaps dealer loses. If it falls below
the price, the investor has overpaid.
Swaps dealers are most
often big Wall Street financial firms, which hedge their own deals
through investments in the regulated futures market. As in the futures
market, the majority of players are speculators who have no intention
of ever taking physical delivery of oil or whatever is the underlying
- Credit-default swaps: Like OTC swaps, these are
private contracts between parties but the underlying asset on these
instruments is debt. The underlying debt can be pooled mortgages that
are packaged into a bond, or other types of loans that are packed
together and sold into a secondary market through a process called
The insurance-like swaps allow investors to take
a position opposite to their exposure in the debt product they hold.
The size of this unregulated market is estimated to be as much as $62
trillion. The lack of any sort of clearinghouse or settlement mechanism
poses risks to the entire global financial system. New York state has
moved recently to try to regulate some credit-default swaps.