For the first time since the Great Depression, the US central bank has opened up its lender-of-last-resort facility to investments banks as part of a package of measures that included a backup credit line to help persuade JPMorgan Chase to rescue Bear Stearns .

Normally, the privilege of borrowing directly from the central bank is extended only to commercial banks and comes with strings attached - direct Fed regulation. The Fed, however, does not regulate investment banks, which are under the watch of the Securities and Exchange Commission.

That seems likely to change, given the Fed's role in rescuing Bear Stearns as well as political momentum behind bold steps to prevent future crises. The upcoming US presidential election also bodes well for efforts to tighten the regulatory regime.

Democratic Party politicians were quick to blame the country's fragmented financial rules for failing to prevent the excess risk-taking that fuelled the subprime mortgage crisis.

Some experts acknowledged that they had a point.

'There needs to be a much more integrated flow of information about all players, whether they are regulated today or not, in terms of where the exposures are really ending up, the clearing processes, and the validity of the auditing, internal control and risk systems,' said former Fed Governor Susan Bies, who left the central bank last year.

This assessment marks a departure from the long-standing less-is-more regulatory culture that held sway within the Fed under the chairmanship of Alan Greenspan, and which his replacement Ben Bernanke showed little desire to alter when he took the helm in February 2006.

Indeed, the SEC is now drawing fire for its light touch.

Representative Barney Frank, chairman of the powerful House of Representatives Financial Services Committee, is cooking up a fresh approach to create a financial czar or give that role to the Fed.

'Once we repealed the Glass-Steagall Act ... we put investment banks and commercial banks into similar activities, but with a differential set of regulations, and it seems as if we have been hurt by the absence of appropriate risk-management mechanisms in the non-bank area,' Mr Frank told the CNBC cable television channel on Friday.

Fractured regulation
The Glass-Steagall Act, repealed in 1999, was forged after of the Great Depression to strengthen the financial system. It split the activities of commercial and investment banks and created deposit insurance for commercial banks, placing them under the regulation of the Fed in return.

The US Treasury has laboured for months behind the scenes to come up with a plan to revamp regulation of the financial services industry.

But it is unclear whether the proposals, which are likely to be unveiled within a few weeks, will go far enough to satisfy a Democrat-controlled Congress demanding tough action.

Treasury Secretary Henry Paulson says new regulation must be balanced against the risk of stifling the innovations that freely operating markets can bring.

Whatever Treasury proposes, updating the regulatory framework will likely be a task left for Mr Paulson's successor after November's US presidential election.

'It is not anything that will happen soon, but it almost seems inevitable,' said Tom Gallagher, senior managing director at investment advisory firm ISI Group in Washington.

'To me the combination of the Bear Stearns rescue and this new facility is that the counterparties for primary dealers are now de facto insured. ... Now primary dealers have the best of both worlds,' Mr Gallagher said.

Like commercial banks, investment banks face capital rules, which are being updated by the global Basel II capital-adequacy directive to take more account of off-balance sheet risks.

But the SEC's compliance-based regulatory approach is different to the scrutiny imposed by Fed regulators, who have their own offices in the headquarters of the biggest banks and examine risks with a view toward safety and soundness that encourages a greater dialogue.

Ms Bies said fragmented regulation, which hindered the spread of information and let risks build up off the radar screen, was an important source of regulatory failure that let the seeds of the current crisis grow. She said the Fed was best-placed to remedy this ill.

'That is the real root cause of what we are talking about. And to me it just makes sense that that should be part of the central bank. They are the lender of last resort. They need to be able to move at a moment's notice. They don't have time to get up the learning curve of what is going on in an organisation,' she said. -- REUTERS