Unlike commercial banks that must maintain strict levels of reserves, investment banks have much looser capital requirements. And unlike banks, the firms could not borrow from the Fed, until the Bear-triggered crisis prompted the Fed to temporarily extend lending to Wall Street.
But calls for expanded regulatory oversight mounted after Bear Stearns Cos. Inc.s proposed fire sale to JP Morgan Chase & Co. and the Feds $30 billion backing of the rescue raised eyebrows in Washington.
Senate Banking Committee Chairman Christopher Dodd, D-Conn., scheduled a hearing on the matter for April 3, with Fed Chairman Ben Bernanke, SEC Chairman Christopher Cox and Mr. Paulson who was contemplating regulatory reforms before the Bear Stearns crisis asked to testify.
Washington observers expect the hearing to be the first step toward legislation seeking to alter the regulatory system. But money managers are concerned that bringing too much change in an atmosphere of crisis could result in more harm than good.
Regulatory processes are always under evaluation and should be constantly challenged, evaluated and altered when it makes sense. But I dont think its a great time to make a host of changes
, said James Paulsen, chief investment strategist at Wells Capital Management, Minneapolis, with $113 billion in assets under management.
I dont think we are in need of wholesale changes. Certainly, over the next few years, we should look into what can reduce the panicky atmosphere in this crisis, but Im less enamored with the knee-jerk reaction that we need to do something quick. Crisis is something that is part and parcel of the capitalist system, Mr. Paulsen said.
Milton Ezrati, senior market strategist and economist at Lord Abbett & Co., in Jersey City, N.J., worries about congressional overreaction.
Putting the investment banks under the Fed seems a regulatory simplification, like saying they are all banks, investment and commercial banks alike, and we are going to treat them all like banks. It becomes a semantic argument. Centralizing regulations and recognizing that these institutions are not different from each other is reasonable. But Congress always overreacts and could impose such regulations that the financial system could no longer support the economys dynamism, Mr. Ezrati said. Lord Abbett has $100 billion under management.
Financial crises are not uncommon at all in the U.S., where it is common to lose sight of risk, especially during a rapid expansion phase, Mr. Ezrati noted, adding that once-Wall Street powerhouse Drexel Burnham Lambert was allowed to fall into bankruptcy without triggering the collapse of the system in the 1980s.
By backing the Bear Stearns acquisition, the Fed has put more than its reputation at risk. Putting up money provides the rationale for its right to scrutinize the investment banking sector it is trying to keep afloat. While trying to alleviate the credit squeeze by accepting mortgage paper as collateral for lending to investment banks, the Fed is also taking a chance, however small, of default, which would ultimately fall on the taxpayers.