FDIC chief calls for tighter investment bank rules

A top U.S. banking regulator says the government must do a better job of planning for the failure of a large investment bank after the near-collapse of Bear Stearns Cos.

Investment banks have looser government oversight than commercial banks, whose financial stability is more closely supervised by regulators.

Ever since the swift decline and government-backed rescue of Bear Stearns in March, policymakers have debated whether investment banks should be subject to tighter controls.

Sheila Bair, chairman of the Federal Deposit Insurance Corp., said Wednesday the government should prepare contingency plans in the event a major investment bank fails. Investment bank regulation should more closely resemble that of commercial banks, which are subject to heavy scrutiny by the FDIC and other regulators, she said.

"The government cannot be put in the position of having to simply write a blank check when these institutions get into trouble," Bair said in a speech to the Exchequer Club, a group of banking industry lawyers, lobbyists and trade association officials.

Continuing trouble at investment banks has been apparent this week. Lehman Brothers Holdings Inc. posted a stunning $2.8 billion loss on Monday, and Morgan Stanley said Wednesday that its quarterly profit dropped by 61 percent.

While Congress appears unlikely to tackle the thorny issue of overhauling financial regulations this year, initial discussions are getting started.

One possibility would be for the FDIC to run a failing investment bank after Federal Reserve or the Securities and Exchange Commission decided to shut it down, Bair told reporters following her speech. The FDIC has long done so for commercial banks, and has handled four bank failures this year.

However, at least one analyst questioned whether such a sweeping change to financial regulations would be effective, given that hedge funds, overseas investors and other financial players likely could elude U.S. oversight.

"It's a fundamentally absurd idea that Congress can ensnare everybody," said Bert Ely, a banking industry consultant in an Alexandria, Va.

Lawmakers have expressed concern over the Federal Reserve-backed rescue of Bear Stearns as it came close to filing for bankruptcy protection. Bear Stearns was acquired by JPMorgan Chase & Co. in March with loan assistance from the Fed.

Some Democratic lawmakers have questioned why the central bank put $29 billion at risk in the JPMorgan-Bear deal to protect Wall Street, while millions of homeowners face the risk of defaulting on their mortgages and losing their homes. Bair, however, defended the Fed's actions as a necessary step to shore up the financial system.

"There is a playbook for the failure of a commercial bank ... but there isn't any for the failure of an investment bank," she said. "The Fed had to invent one on the fly."

The Fed in March agreed for the first time to allow big investment houses to temporarily receive emergency loans directly from the central bank. That mechanism, similar to one already available for commercial banks, was the broadest use of the Fed's lending authority since the 1930s.

Fed Chairman Ben Bernanke and his colleagues opened the facility as the central bank raced to deal with the sudden crash of Bear Stearns. Bair said it would be "almost impossible" for regulators to reverse course, given the precedent of that rescue.