Will, not mandate, needed for better bank oversight

By Pedro Nicolaci da Costa

NEW YORK (Reuters) - A White House plan to overhaul financial regulation would broaden the Federal Reserve's reach, but more effective oversight will require changing minds as much as laws.

The Fed's existing regulatory mandate, including direct supervision of commercial banks, is already vast. Yet policy-makers have exhibited a distaste for intervention that some analysts say allowed housing and securities markets to run amok.

With the financial crisis now entering its ninth month and credit losses already totaling over $200 billion, officials have found themselves with no option but to step in.

But critics argue the central bank is simply laying the groundwork for future bubbles by reacting to trouble rather than preventing it. This makes some analysts skeptical that a major shift in the Fed's approach to policy is imminent.

"I'm concerned over whether the Fed will have enough information to step in and try to prevent problems from getting out of hand instead of always coming in after the event to clean up a mess," said Nigel Gault, director of U.S. economic research at Global Insight.

Not only did the Fed not flex its regulatory muscle in anticipation of the subprime mess, it also failed to employ what is arguably its most powerful policy tool: the power of persuasion.

Rather than talking down the frothy housing and real-estate bond sectors, the Fed hailed them as beacons of financial innovation, with severe consequences for the U.S. and global economies.

"They should have taken away easy money sooner, and they should have reined in bad lending practices," said Eric Green, economist at Countrywide Financial, whose own firm has had a prominent role in the subprime mortgage debacle.