Paulson warns Wall Street of new oversight

WASHINGTON —  Signaling a willingness by the Bush administration to expand its oversight of Wall Street, Treasury Secretary Henry M. Paulson Jr. said Wednesday that investment banks should submit to greater supervision if they want regular access to Federal Reserve loans.

With Congress increasingly inclined to consider additional regulation of the mortgage industry -- including Wall Street firms -- Paulson’s statement, though limited, marks a significant shift from the position the administration held before the current credit crisis.

The Treasury chief spoke amid fresh congressional scrutiny of the government’s role in JPMorgan Chase & Co.’s agreement last week to acquire troubled brokerage Bear Stearns Cos.

The Fed underwrote the Bear Stearns deal by agreeing to lend JPMorgan $30 billion. The central bank then said it was temporarily allowing other major Wall Street firms to also borrow directly from the Fed via its “discount window,” which since the 1930s has been restricted to banks that accept traditional deposits.

Two leading senators sent a letter Wednesday to Paulson, Fed Chairman Ben S. Bernanke, the head of the Federal Reserve Bank of New York and the chief executives of JPMorgan and Bear Stearns asking for detailed information on the arrangement agreed to by the two financial giants and the Fed.

“It’s the Finance Committee’s responsibility to pin down just how the government decided to front $30 billion in taxpayer dollars for the Bear Stearns deal,” Chairman Max Baucus (D-Mont.) said in a statement. “Economic times are tight on Main Street as well as on Wall Street, and we have a responsibility to all taxpayers to review the details of this deal.”

The letter was cosigned by the committee’s top Republican, Charles E. Grassley (R-Iowa).

Meanwhile, Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, scheduled hearings on the transaction for next week.

When it opened the discount window to non-banks, the Fed said it would continue to make such loans available for six months. In a speech Wednesday before the U.S. Chamber of Commerce, Paulson insisted that if investment banks wanted the right to borrow from the Fed after that six-month period, they should open their books.

“Access to the Federal Reserve’s liquidity facilities traditionally has been accompanied by strong prudential oversight of depository institutions,” Paulson said. speech”Certainly, any regular access to the discount window should involve the same type of regulation and supervision.”

Paulson heads an administration task force that is expected soon to release recommendations for regulating the financial markets, which have been unsettled by the credit crunch and housing downturn.

Because bank deposits are insured by the federal government, traditional banks submit to federal regulation so taxpayers are not unfairly exposed to risk from irresponsible business practices. Similarly, Paulson argued, if investment banks want the backing of the Federal Reserve, the central bank needs to “protect its balance sheet and ultimately protect U.S. taxpayers.”

“The Federal Reserve should have the information about these institutions it deems necessary for making informed lending decisions,” he said.

The Fed’s discount window makes loans to banks that face short-term needs for liquidity. The discount rate is generally higher than the federal funds rate, which banks charge one another for overnight loans to meet reserve requirements. The Fed last week cut the discount rate to 2.5% and the federal funds rate to 2.25%.

Paulson, who used to head Wall Street investment house Goldman Sachs Group, said he considered the Fed’s move to lend to non-banks temporary.

“Despite the fundamental changes in our financial system, it would be premature to jump to the conclusion that all broker-dealers or other potentially important financial firms in our system today should have permanent access to the Fed’s liquidity facility,” he said. “Recent market conditions are an exception from the norm.”

The turmoil in the financial markets has spurred debate in Washington over new regulations to prevent a repeat of incautious lending practices that inflated and eventually popped a speculative bubble in the housing market.

“A correction was inevitable, and the sooner we work through it, with a minimum of disorder, the sooner we will see home values stabilize, more buyers return to the housing market, and housing will again contribute to economic growth,” Paulson said.

Paulson reiterated the Bush administration’s opposition to permitting homeowners who owe more than their houses are worth to have their debts reduced.

“Negative equity does not affect borrowers’ ability to pay their loans,” he said. “Homeowners who can afford their mortgage payment should honor their obligations, and most do.”

Paulson noted that negative equity has become common because recent lending practices permitted borrowers to get mortgages with small or no down payments. He said that people who lived in their homes for the long term would eventually make up the lost equity.

“Any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator,” he said. “Washington cannot create any new mortgage program to induce these speculators to continue to own these houses, unless someone else foots the bill.”

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maura.reynolds@latimes.com