Fed calls for overhaul of financial regulatory system

WASHINGTON -- Federal Reserve Chairman Ben Benanke laid out a far-reaching proposal Tuesday to strengthen government oversight of banks, mutual funds and huge financial firms to prevent a repeat of the current worldwide crisis, which he termed the "worst financial crisis since the 1930s."

In a speech to the Council on Foreign Relations, Bernanke said the USA and other industrial nations bore special responsibility for the spreading global crisis due to their failure to address chronic trade imbalances and clamp down on speculation.

In the near term, the U.S. and other governments must focus on getting lending restarted, because recovery "depends critically on our ability to get the banking system and the financial system ... back to a situation where the markets are reasonably stable," Bernanke said. The U.S. recession will end later this year only if the financial system is repaired, he said.

Bernanke said U.S. unemployment of more than 10% is "within the realm of possibility."

Bernanke laid out four key elements for systemic reform. High on his list is addressing financial institutions considered too big to fail — which he called an "enormous" problem — including setting up a system to restructure troubled firms. Another is bolstering systems and rules governing trading and payment in financial markets, to ensure they hold up under stress.

Bernanke suggested reviewing current rules to ensure they don't have the unintended consequence of magnifying ups and downs.

The Fed chair gave, as one example, regulations requiring banks to hold a certain amount of capital. Because it's tough to raise capital in a downturn, banks may cut lending to meet capital rules, making things worse.

Bernanke raised the idea of a super-regulator to monitor systemic risks. He said he had an open mind on whether the Fed should assume the lead role, though it would need to be involved in any systemic management.

The Senate Banking Committee held a hearing Tuesday on financial regulation, with Chairman Chris Dodd, D-Conn., saying, "The era of 'don't ask, don't tell' on Wall Street is over."