Federal Reserve chairman Ben Bernanke outlined his plan to overhaul the financial regulatory system, calling for a reform while addressing the Council of Foreign Relations on Tuesday.
Bernanke said changing accounting methods have exacerbated the financial crisis and pushed for improved tools to allow the orderly resolution of a systemically important nonbank financial firm, including a mechanism to cover the costs of the resolution.
One way would be for the Congress to direct and empower a governmental authority to monitor, assess, and, if necessary, address potential systemic risks within the financial system.
''We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components," he said.
However, he also said that though strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim,'' the Fed chairman said.
''The policymakers must better supervise institutions perceived as too big to fail and consider requiring firms to set aside more capital so that they have it when economic conditions worsen,'' he opined.
Saying that these crises had revealed shocking gaps in regulatory oversight, Bernanke asked, "I mean, who was overseeing the subprime lenders, for example? Who was overseeing AIG (American International Group)? There simply was not enough adequate oversight in those cases."
Rules underlying "mark-to-market" or "fair-value" accounting now require companies to disclose the value of certain types of assets based on what buyers would pay for them if they were to be sold now. But because buyers have fled the marketplace, driving down prices, companies have been forced to write down the value of their assets, even if they don't plan to sell them for years, he noted.
Mark-to-market rules are intended to give investors a clear and accurate picture of the value of a company's assets. Bernanke said that though it remained an appropriate system, he said policymakers should identify the weak points of mark-to-market system "and try to make some improvements on a more expeditious basis."
That could mean that certain kinds of assets now valued at their market price would instead be valued according to their underlying economic value, which is generally higher.
Systemic risk regulator
Among the most sweeping changes lawmakers are considering is the creation of a regulator to monitor firms that pose a systemic risk because they are so interconnected with other firms.
The idea of a systemic risk regulator has been around for a while but has taken on new urgency following the failure of Lehman Brothers and the government takeover of AIG.
Bernanke urged coordination with bank regulators abroad but stopped short of endorsing an international financial regulatory regime -- an idea that has been pushed by some European leaders.
According to the Fed chief, the infrastructure for managing credit default swaps and other over-the-counter derivatives is still not as efficient or transparent as that for more mature instruments.
He calls for enhancing the resilience of the tri-party repurchase agreement (repo) market, in which the primary dealers and other major banks and broker-dealers obtain very large amounts of secured financing from money market mutual funds and other short-term, risk-averse sources of funding.
Bernanke said there was a ''good chance'' the US recession could end this year if the government is successful in getting financial markets to operate more normally again.
"We will eventually recover. There's no question," he added. "There is too many underlying strengths. It is too dynamic an economy. It is a question of whether it happens quickly or less quickly."
The Fed chief's remarks come as the Obama administration and Congress are crafting their overhaul strategies. For the administration, critical work will be carried out among global finance officials this weekend in London.
On Tuesday, IMF managing director Dominique Strauss-Kahn said that the global economy is shrinking with economic growth falling below zero in several economies and world trade falling at an alarming rate (See:Global economy shrinking with below zero growth: IMF).
IMF expects global growth to slow below zero this year, the worst performance in most of our lifetimes.
In its report, the World Bank predicted that the global economy will shrink this year for the first time since the 1940s, reducing earlier estimates that emerging markets would propel the world to positive growth.
The report said that 94 out of 116 developing countries have been hit by economic slowdowns.
As a result, the report estimates that at least 98 countries may have problems financing at least $268 billion in public and private debt this year. It noted a worsening in market conditions could raise that figure as high as $700 billion.