Financial regulators, lulled into inaction by soaring bank and Wall Street profits, failed to protect Americans from the 2008 financial crisis, senior U.S. officials told an investigative panel on Thursday.

In testimony that urged stricter oversight in future while admitting past errors, Federal Deposit Insurance Corp Chairman Sheila Bair headlined a second day of public hearings by Congress' Financial Crisis Inquiry Commission.

Not only did market discipline fail to prevent the excesses of the last few years, but the regulatory system also failed in its responsibilities, she said.

Record profitability within the financial services industry also served to shield it from some forms of regulatory second-guessing, Bair told the commission.

When financial firms are making money, even amid questions about how they are doing it, it can be difficult for regulators to take away the punch bowl, she said.

The 10-member panel, in its first public hearing on Wednesday, heard a tale of misjudgments and regret from top banking executives, but got no outright apology or any new explanations for the debacle that shook world markets.

The bankers acknowledged taking on too much risk and having choked on their own financial cooking in the subprime mortgage market, but they defended their pay packages and the huge size of their businesses in the face of proposals to break them up.

The commission, chaired by former California State Treasurer Phil Angelides, is beginning its work amid rising public fury over the crisis, its aftermath and what to do to prevent something like it from happening again.

President Barack Obama said on Thursday he was determined to impose a fee on big banks to ensure all taxpayer money used to bail them out was recovered.

The banking titans set off a media circus on Capitol Hill on Wednesday, but the regulators met with a half-empty hearing room. Discussion between them and the panel was more subdued than the sometimes combative exchanges with the bankers.

Attorney General Eric Holder even left the hearing early, after making a statement, because of another engagement.

In addition to Bair, the commission heard from Securities and Exchange Commission Chairman Mary Schapiro, who said a program set up by the SEC in 2004 to supervise investment banks was a failure. The program was ended in September 2008.

The Consolidated Supervised Entities program, based on voluntary regulation, was inadequately staffed; over-stretched the SEC's traditional capabilities; and unwisely let firms hold lower levels of capital, she said.

We have to conclude that that program was not successful, she said of the ill-fated attempt by the SEC to oversee global giants such as Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch and Bear Stearns.

Schapiro said the SEC is now reviewing investment bank practices in markets for subprime mortgage-backed securities and collateralized debt obligations in the real estate bubble.

We are seeking to determine whether investors were provided accurate, relevant and necessary information, or misled in some manner, Schapiro said.


Reuters Insider coverage of the Financial Crisis Inquiry Commission hearing:



The FDIC and SEC were deeply involved in the run-up to the crisis that peaked in late 2008 after the collapse of former investment banking giant Lehman Brothers.

Bair made waves this week with an FDIC proposal calling for banks with risky compensation schemes to pay higher deposit insurance premiums. It reflects Bair's readiness to experiment with using the FDIC's policy levers to influence bank behavior.

She was an early critic of subprime mortgage market excesses that helped inflate a historic housing price bubble well into 2007. When it broke, the aftershocks paralyzed capital markets and panicked the Bush administration.

Multibillion-dollar taxpayer bailouts and the deepest recession since the 1930s followed, saddling President Barack Obama with profound economic challenges and a political backlash that is still far from over.

The Angelides panel is modeled after the Pecora Commission, which probed the 1929 Wall Street crash. Its findings helped lead to the creation of the SEC and other reforms. Whether the new commission will be as substantive remains to be seen.

Its work coincides with efforts in Congress to overhaul financial regulation, a process now more than a year old and in which Bair has emerged as a key innovator.

The House of Representatives last month approved a sweeping reform bill over the objections of Republicans and banks. The Senate is working on a bill. By summer, a compromise House-Senate bill could reach President Barack Obama. (Additional reporting by Karey Wutkowski, Jeremy Pelofsky, Rachelle Younglai, Steve Eder; Editing by Tim Dobbyn)