Frank looks ahead to the next step
Congressman calls for more regulation of financial industry
NEWTON - US Representative Barney Frank yesterday staked out the next battlefront in the economic crisis gripping the world: more regulation of hedge funds, investment banks, and other financial institutions.
Frank, who heads the House Financial Services Committee, blamed a lack of strict oversight for the failures of Wall Street investment banks such as Bear Stearns Cos. and Lehman Brothers Holdings Inc., as well as dozens of subprime mortgage companies. He said hedge fund investments in arcane securities based on those mortgages deepened the crisis, which has spread worldwide. In contrast, heavily regulated commercial banks escaped the crisis largely unscathed, Frank said.
"The cause of this problem was a lack of financial regulation in the industry," the Massachusetts Democrat said at a Newton City Hall press conference, one of two events he held in the Boston area yesterday. "If the regulated institutions had made loans, we would not be in the crisis we're in."
Frank called for requiring hedge funds, equity firms, and investment banks to maintain higher capital levels, as banks already do, and to disclose their investment activities. He also proposed tougher regulation of arcane securities, which caused massive losses at American International Group and forced a federal takeover of the nation's largest insurer.
To ensure that, he proposed expanding the Federal Reserve's powers to oversee the firms.
Republicans in Congress, backed by the $1 trillion hedge fund industry, are expected to oppose increased regulation, saying the current problems have their roots in 1970s legislation that regulated bank lending. Because hedge funds are private and usually only open to wealthy individuals and institutions, they are not subject to the same rules as mutual funds.
Richard C. Wilson, who heads the Hedge Fund Group, a Boston trade organization, said the focus on regulating hedge funds was misguided. Lenders are to blame for today's financial meltdowns, he said.
"There's no hedge funds being bailed out by the US government," Wilson said. "The banks need to be bailed out because they're providing supposedly riskless instruments that turn out to be far from riskless. That's where there needs to be more regulation.
In fact, three major commercial banks were seized by the Federal Deposit Insurance Corp., including IndyMac Bank in July. Last month, the FDIC directed the sale of Wachovia to Citigroup in a deal now being contested by Wells Fargo & Co., which also wants to acquire Wachovia. And last month, the FDIC also seized Washington Mutual and sold its assets to JPMorgan Chase & Co.
Dozens of lightly regulated subprime lenders, including New Century Financial Corp., have failed and troubled Countrywide Financial Corp. was acquired by Bank of America Corp.
Frank also wants more scrutiny of credit default swaps, which he said deepened the crisis. Credit swaps are essentially insurance policies to protect investors from losses in mortgage-backed securities. Many investors speculated in that market to earn quick profits, triggering even bigger losses at financial firms such as AIG and causing the stress in the subprime mortgage industry to spread to the entire US - and world - financial system.
By contrast, Frank said, AIG's regulated insurance divisions remained profitable.
In response to Frank's comments, US Representative Spencer Bachus of Alabama, the ranking Republican on the Financial Services Committee, said it's not the time to assess blame for the fiscal crisis. "Almost everyone shares some degree of blame," he said. But Bachus also suggested he might support regulations.
Frank launched a broadside at a host of Wall Street practices he said worsened a financial crisis initially caused by the torrent of money invested in high-risk subprime mortgages. As interest rates and payments on those loans rose, a record number of homeowners faced foreclosure.
Frank said the Federal Reserve already has cracked down on subprime lending. But he added that oversight of the financial industry in the past - such as a rule banning individual investors with less than $1 million from investing in hedge funds - proved inadequate. He said that rule protected individual investors but not the overall economy from high-stakes investment tactics.
Hedge funds, private equity firms, and investment banks need to disclose their investment activities, he said. "Nobody knows who's got what or who's dealing with who."
Conservative Republicans blame a 1977 regulation - the Community Reinvestment Act - for the subprime mortgage fiasco. The law required commercial banks to disclose all loans they made and to make loans in inner-city neighborhoods where they drew deposits. That led banks to make loans to people who could not afford them, according to Republicans.
Frank derided conservatives for trying to protect financial firms' freedom to trade credit default swaps.
"That's not my definition of freedom," he said. "Freedom is what I can read, what I can say."
Jenifer B. McKim of the Globe staff contributed to this report. Kimberly Blanton can be reached at blanton@globe.com. 