Steel urges caution in laws on bank collapses

By Rebecca Christie  |   2008-7-7  |     NEWSPAPER EDITION

UNITED States Treasury Undersecretary Robert Steel has urged caution when it comes to federal protection of financial firms that don't take consumer deposits - such as investment banks.

"I think to pull too many other institutions into that arena is a mistake," Steel said last Saturday during a panel discussion at an Aspen Institute conference in Colorado.

The remarks illustrate Treasury concerns about any regulation that might encourage reckless behavior, as it considers proposals that would allow financial firms to go out of business without threatening market stability.

Treasury Secretary Henry Paulson last week called for regulatory changes in the US to deal with the failures of companies that don't take deposits, such as investment banks. He identified a legal gap that fails to cover that situation, according to Bloomberg News.

Federal Deposit Insurance Corp Chairman Sheila Bair has urged that an agency be given power to take over and liquidate investment banks in an orderly manner. The FDIC has that power over lenders whose deposits it insures.

Broader powers

"If we overprescribe regulation, we're going to reduce market discipline, which has the moral-hazard effect of encouraging people to take risk because they think they'll be bailed out," Steel said in Colorado.

US regulators and legislators are debating plans to alleviate the yearlong credit crisis that has caused US$402 billion of writedowns and credit losses worldwide. Paulson has proposed giving the Federal Reserve broader powers as a "macro-stability regulator."

Paulson and Fed Chairman Ben S. Bernanke are scheduled to testify last Thursday before the House Financial Services Committee on financial-market regulation.

The two officials will also respond to law makers' questions about the Fed's decision in March to agree to take on about US$30 billion in illiquid Bear Stearns Cos debt and open lending to investment banks.

Other speakers at the Colorado panel said regulators should be careful about spelling out what types of institutions they will bail out and when. "It is a good idea to have it be really unclear as to whether the Fed is going to save something or not," said William Mayer, who was CEO of First Boston until 1990 and is now a partner at Park Avenue Equity Partners in New York.

"The worst thing we could do is say here are the commandments, and right here is where we stop. I don't believe you'd want to do that."

Steel said he expected financial markets to make "uneven" progress as they recover from the crisis.