Financial industry may face new rules next year

updated 3:40 p.m. ET Oct. 5, 2008

WASHINGTON - With the passage of the $700 billion rescue package, the financial industry will face greater congressional scrutiny in coming weeks and months.

Further-reaching regulation is almost certain. Previously obscure corners of the industry now subject to few rules, such as complex derivatives and hedge funds, could face federal supervision for the first time.

Meanwhile, heavily regulated sectors, such as banking and insurance, are likely to face greater oversight. Even some financial industry groups support federal oversight for the insurance industry, which is now regulated only at the state level.

"Clearly, next year we will have more regulation," said Scott Talbott, a lobbyist for the Financial Services Roundtable, a group of the 100 biggest companies in the industry.

Having passed the bailout bill, Congress is now shifting its attention to its next steps.

"Passing this legislation is only the beginning of our work," said House Speaker Nancy Pelosi, D-Calif., just before the House approved the package.

Rep. Barney Frank, D-Mass., the Financial Services Committee chairman, said next year Congress will seek to overhaul housing policy and financial regulation in a legislative effort he likened to the New Deal.

"We were the EMTs rushing to the rescue of an economy that suddenly found itself choking, but now we have to perform more serious reform," Frank said.

The bailout bill, approved by the Senate Wednesday, provides $700 billion to buy bad assets from banks and other institutions to shore up the financial industry.

Hearings that begin Monday will examine the failures of current regulations. The House Oversight and Government Reform Committee, chaired by Rep. Henry Waxman, D-Calif., will hold two hearings on the causes and effects of Lehman Brothers' bankruptcy and on the $85 billion bailout of the giant insurer American International Group Inc.

The committee will hold three more hearings this month on hedge funds, credit rating agencies and the role of regulators in the run-up to the crisis.

Former Federal Reserve chairman Alan Greenspan has been invited to testify at the third hearing, the committee said.

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Meanwhile, the House Agriculture Committee, which has some oversight of commodities and futures trading, plans to hold a hearing this month on a class of derivatives known as credit default swaps. AIG held huge amounts of credit default swaps, which act as insurance against bond defaults. The prospect that AIG wouldn't be able to pay out the swaps was a major reason the government took over the company.

Hedge funds, which invest huge pools of money for wealthy investors and pension funds, are part of what some analysts call the "shadow banking" system that also included investment banks such as Lehman.

The "shadow" system provided the capital for many subprime mortgage brokers by buying huge amounts of mortgage-backed securities and creating demand for more mortgage loans.

Credit rating agencies such as Moody's Investors Service, Standard & Poor's and Fitch Ratings have been criticized for slapping their top ratings on complex mortgage-related securities that few investors are now willing to buy.

The battle lines are already emerging for next year's fight. Industry lobbyists will push to consolidate the numerous financial regulatory agencies, similar to a proposal outlined by Treasury Secretary Henry Paulson earlier this year. To prevent future meltdowns, they want the Federal Reserve to focus on "systemic risk," or the risk that individual banks pose to the larger financial system. Currently, regulators focus too much on individual banks in isolation, Talbott said.

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