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Paulson proposes major new role for the Fed

The central bank would oversee all financial markets, under a new plan.

By Ron SchererStaff writer of The Christian Science Monitor / April 1, 2008

Sweeping plan: Treasury Secretary Henry Paulson outlined Monday the biggest overhaul in financial regulation since the Great Depression.

J. Scott Applewhite/AP

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The Federal Reserve already manages the economy: setting interest rates, supervising banks, making sure the nation's payment systems operate efficiently. Now, the Bush administration is proposing that the Fed become a supercop for the nation's financial system.

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But should the central bank be that powerful? Can an unelected group of overseers – whose record in dealing with the latest financial crisis looks mixed – also run the world's leading capital markets?

Those are two key questions already percolating in the halls of Congress – and beyond – in the wake of Treasury Secretary Henry Paulson's call for a sweeping reform of the financial system. The plan would represent the biggest overhaul since the Securities Act of 1934, a legislative reaction to the financial abuses that led to the Great Depression.

Under Mr. Paulson's proposal, the Fed would become a "market stability regulator," gathering information, collaborating with other regulators, and monitoring risk across the board. But the Paulson plan also envisions a "prudential regulator," which would focus on the safety and soundness of firms with federal guarantees. And the Fed would also be involved in a revamping of the mortgage origination business, perhaps as part of a new Mortgage Origination Commission, which will undertake a review of the entire home lending system.

"This is a complex subject deserving serious attention. Those who want to quickly label the blueprint as advocating more or less regulation are oversimplifying this critical and inevitable debate," said Paulson in his speech on Monday. "The blueprint is about structure and responsibility."

Once Congress focuses on the Paulson plan, it is likely to be a heated debate.

Some finance experts argue the Fed already has its hands full.

"A case could be made where the Fed just focuses on monetary policy," says Kenneth Thomas, a finance expert at the University of Pennsylvania's Wharton School. "Bernanke has his hands full."

He says the Fed also fell flat in recent years in its current regulatory role, raising questions about whether to extend new powers on that front. For example, banks shifted a lot of their risks off their balance sheets, thus negating the need to set up reserves against losses. "Where were they in terms of monitoring the level of off-balance-sheet risk" that banks were taking with complex investments? asks Mr. Thomas.

However, other finance experts believe the time is right for a major overhaul of a system that may be vastly out of touch with the markets. "The Fed has to have enough authority to know where the bombs are hidden," says Doug Roberts, a monetary expert at Channel Capital Group in Shrewsbury, N.J.