Fed heightens its scrutiny of investment banks

US Federal Reserve staff move into several Wall Street investment banks

NEW YORK – US Federal Reserve staff have moved into several banks on Wall Street to enable them to keep a closer eye on bank activity during this time of market volatility, according to a report in the Times newspaper. Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch and Bear Stearns are all subject to personal monitoring by the Fed.

This comes on the heels of the Fed’s decision to finance JP Morgan’s takeover of Bear Stearns, which is a departure from its traditional role to extend emergency loans to commercial banks only. Full details of the negotiation emerged in a testimony before the Senate Banking Committee yesterday. There, top officials from the Federal Reserve, the Treasury Department and the Securities and Exchange Commission defended themselves against criticism that the government should have taken more aggressive steps months, or years, earlier to prevent the current problems on the financial markets.

The Fed argues that if it is going to continue to be the lender of last resort for the securities firms, it should keep a closer eye on the banks’ activities. As such, the New York Fed is gathering evidence on key traders’ activities and is compiling lists of names and numbers of key traders in specific, esoteric securities such as auction rate preferred securities to try to get a better understanding of the products and whether the market is liquid and what the perceived losses will be. In this way the Fed hopes to ascertain how effective the measures it has taken so far have been, where the biggest dangers lie in the financial system, and how best to control or mitigate them.

There has been no comment from the Fed itself on this increase in market scrutiny, however.