SEC's Cox says investment banks play unique role

Having investment banks follow the same rules as commercial banks would hurt the U.S. financial system and drive risk-taking business outside of government oversight, the head of the Securities and Exchange Commission said Thursday.

As Congress considers overhauling the regulation of financial markets, SEC Chairman Christopher Cox told a House hearing that "imposing the existing commercial-bank regulatory regime on investment banks would be a mistake."

In some areas, such as limits on how much a financial institution can borrow relative to its capital, investment banks are less tightly regulated than commercial banks.

By putting the two kinds of institutions on the same regulatory level, Congress could create a framework for investment banks that would "discourage risk taking ... and restrict lines of business," Cox told the House Financial Services Committee.

Firms falling outside the umbrella of government supervision, such as hedge funds, likely would take over the higher-risk role now constructively played by Wall Street investment banks, he said.

The near-collapse of investment bank Bear Stearns Cos., a crisis of confidence in mortgage finance giants Fannie Mae and Freddie Mac, and the failure of savings and loan IndyMac Bank, have brought urgency to the financial regulation debate. A number of Bush administration officials and independent regulators have been urging prompt changes _ either by giving more power to the SEC or the Federal Reserve _ to meet the threat of a financial system breakdown.

Amid the crisis, the Fed for the first time has allowed big investment banks to temporarily get emergency loans from the central bank _ a facility available to commercial banks for years. Hundreds of billions of dollars have been extended as a backstop through the so-called "discount window" in recent months as the Fed has intervened to avert financial disaster.

If investment banks were to be regulated like commercial banks, they might gain permanent access to the Fed's discount window.

While Cox wants the SEC to supervise Wall Street investment banks at the level of their parent holding companies, Fed officials say the current system, in which the central bank is the primary overseer of those firms, generally works well.

Timothy Geithner, president of the Fed's New York regional bank, told lawmakers that changing the Fed's role as primary regulator of investment banks "would risk exacerbating moral hazard and adding to uncertainty about the rules of the game." Moral hazard refers to the prospect that financial institutions might be more inclined to take certain risks if they believe the Fed will bail them out.

But the major investment banks recently have made "substantial progress" in bolstering their capital cushions against risk, lessening their potential need to tap into the Fed's emergency lending lifeline, Geithner said.

In addition to opening the discount window to Wall Street investment banks, the Fed on July 13 said it would allow Fannie Mae and Freddie Mac to have that access _ a move decried by Republican members of the House panel who are longtime critics of the two government-sponsored companies.

Fannie, Freddie and 17 large investment banks also are covered by an SEC order temporarily banning a certain kind of short-selling of their stock, which took effect Monday and could last up to 30 days.

A sweeping housing bill, which passed the House Wednesday and is soon expected to do the same in the Senate before being presented to President Bush, includes rescue measures for Fannie and Freddie _ which together hold or guarantee more than $5 trillion in mortgages, nearly half the nation's total. At the same time, it puts the companies under tighter control by the federal government.