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Confusion in FED camp.. finger pointing starts

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5/5/06
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Roots of credit crisis laid at Fed's door
Regulatory minimalism allowed risky practices to flourish, expert says
By Greg Robb, MarketWatch



WASHINGTON (MarketWatch) -- In the wake of the financial market turmoil that arose over the summer and even now threatens to push the U.S. into recession, there has been a remarkable lack of finger-pointing so far over the cause of the crisis.


But one observer, Tom Schlesinger, the founder and executive director of the Financial Markets Center, a think tank that has followed the Federal Reserve closely for the past decade, believes the blame for the crisis falls squarely on the Fed and accuses the central bank of "regulatory foot-dragging" that has harmed the public.

Schlesinger maintains the Fed's prevailing regulatory philosophy has shifted from that of 20 or 25 years ago, which in essence was "here is the line between right and wrong, don't cross it," to a current underlying policy that "anything and everything that might be called financial innovation ought to be embraced."



He points specifically to the opposition to government regulation that flourished at the U.S. central bank under former Fed chief Alan Greenspan and has continued unabated under his successor Ben Bernanke.



By early August, parts of the financial system were close to frozen and central banks were forced to inject billions of dollars to add liquidity to maintain the workings of the credit markets.
Over the last two months, some markets have recovered, but problem areas remain, particularly in the London market for structured investment vehicles, or SIVs. There is concern in financial markets about bank exposure to these investment pools and concern that possible forced sales of their assets might shock already jittery credit markets.

Separately, Bank of America, JPMorgan and Citigroup are leading a plan to raise $80 to $100 billion to help buy some of the assets held by SIVs facing collapse.
But these same international bankers spent last weekend in the corridors of the International Monetary Fund's annual meeting urging government officials not to rush to adopt new rules to get the financial market turmoil under control.

Schlesinger calls this reaction by bankers "misguided, predictable and familiar."

Early warnings went unheeded

Upon joining the Fed, Greenspan said he had a "pleasant surprise" when he found the Fed staff was not so keen on regulation either. Together, they interpreted congressional legislation with a view to "letting markets work," he wrote.
Schlesinger says this practice was actually "regulatory foot-dragging" where the Fed had a clear obligation under law to police markets but went about it "with such reluctance that in some cases the supervision is difficult to detect."

In January 2003, after a review of the collapse of Enron Corp., a Senate investigation found that some major U.S. financial institutions had "deliberately misused structured finance techniques" to help Enron engage in deceptive accounting or tax strategies in return for millions of dollars in fees.

Fed and the SEC opted against coming out with a list of new guidelines, stating that they favored a principles-based approach rather than a more prescriptive approach to regulation. Schlesinger contends this resulted in the agencies issuing final guidance in 2006 "that in essence said do whatever you want -- anything goes."
"This is a perfect example of the unwillingness of the Fed to take a strict approach to policing structured finance products has come back to haunt the entire system," he said.



In an interview on the CBS News' program "60 Minutes," Greenspan said the Fed couldn't stop subprime mortgage originators.

Schlesinger disagrees. Although the abuses came from independent originators and not banks, Schlesinger said the Fed had "all or most" of the authority it needed to police the market under two laws passed by Congress.

The Fed has already promised to craft rules to address deceptive mortgage lending practices.
Schlesinger said he has some hope the regulatory pendulum will eventually move in the other direction, but cautions it won't be an easy shift.
"It will require some real assertiveness in Congress that has been by-and-large pretty passive on these issues. I think it will also take some real dissent, debate and new thinking in academia and the economics profession as well," he said.
 
Hence we see the lowest price for 2 year treasury. Expecting for another rate cut
 
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