WASHINGTON - The Federal Reserve will get a role in setting capital cushions at securities firms under an agreement designed to allay fears a failing financial company without central bank oversight could threaten the economy.
The Fed and Securities and Exchange Commission will collaborate in determining "guidelines or rules concerning the capital, liquidity, and funding" arrangements of investment banks, the regulators said in an accord released yesterday. They will also cooperate in designing "risk management systems and controls" for securities firms.
"This is a pretty momentous agreement," said Gilbert Schwartz, a former Fed associate general counsel who's now a partner at Schwartz & Ballen LLP in Washington.
The agreement to exchange information about financial companies formalizes sharing in place since March when the Fed put examiners in securities firms and began lending them money. The move followed a run on Bear Stearns Cos. that pushed the New York company to the brink of bankruptcy.
The sharing will continue even if the Fed stops lending to securities firms, giving it a permanent hand in overseeing Wall Street. The Treasury Department urged expansion of the Fed's role after the central bank rescued Bear Stearns with $30 billion in financing to secure a sale to JPMorgan Chase & Co.
The Fed will share with the SEC data on commercial banks' "financial condition" that may threaten the companies' brokerage units. The Fed will also provide assessments of financial markets that may affect securities firms.
Officials from the Fed and SEC will meet at least four times a year to exchange information and discuss the companies they regulate.
The agencies are "using our existing authorities and executing our existing responsibilities in a smart way by sharing information that both of us have," SEC chairman Christopher Cox said.
Wayne Abernathy, an executive director at the American Bankers Association, said he's concerned Fed monitoring of investment banks may lead to increased risk-taking.
"The more you get the Fed involved the more you increase the impression that these securities firms have some sort of federal backstop," said Abernathy, a former assistant Treasury secretary. "To the extent you do that, you decrease market discipline."
Erik Sirri, who heads the SEC's trading and markets division, told Congress the memorandum of understanding with the Fed will provide a "bridge" until Congress decides which regulator should have authority over securities firms.
House Financial Services Committee chairman Barney Frank, a Massachusetts Democrat, will begin hearings this week on revamping financial rules.