The Obama administration Thursday unveiled a draft legislation that would grant regulators "sweeping expansion" of authority to seize non-bank financial companies whose collapse could jeopardize the already ailing economy.
FILL SIGNIFICANT VOID
Treasury Secretary Timothy Geithner called for the new power Thursday in testimony before the House Financial Services Committee. He told the panel the current system failed in basic, fundamental ways and has proven to be too unstable and fragile.
"Over the past 18 months, we have faced the most severe global financial crisis in generations," Geithner said. "To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game."
"The new rules must be simpler and more effectively enforced and produce a more stable system, that protects consumers and investors, that rewards innovation and that is able to adapt and evolve with changes in the financial market," he said.
Under the current law, the government can only seize banks. The draft bill would grant it "resolution authority," which would allow the government to impose tougher standards on financial institutions judged to be so big that their failure would represent a risk to the entire system.
It also would extend federal regulations for the first time to all trading in financial derivatives, exotic financial instruments such as credit default swaps, and would require larger hedge funds to register with the Securities and Exchange Commission.
Moreover, it would enable the government to reduce the need for taxpayer funds, said the Treasury.
For example, it would enable the federal agency acting as conservator or receiver to sell or transfer the assets or liabilities of the institution in question, to renegotiate or repudiate the institution's contracts, including with its employees, and to address the derivatives portfolio, thus reducing the potential for further disruption.
"The legislative proposal would fill a significant void in the current financial services regulatory structure and is one piece of a comprehensive regulatory reform strategy that will mitigate systemic risk, enhance consumer and investor protection, while eliminating gaps in the regulatory structure," said the Treasury in a statement.
The U.S. government currently has the authority to seize only banks. A change in the Treasury Department's authority, such broader power over non-bank firms, would need to be approved by Congress.
MAKE TRIGGERING DETERMINATION
Under the draft bill, the Treasury secretary would have to make "triggering determination" before invoking resolution authority.
The secretary would have to find that the firm is in danger of becoming insolvent, that its insolvency would have serious adverse effects on the economy and financial stability, and that taking emergency action would avoid those adverse effects.
"The decision whether to provide financial assistance to the institution or to put it into conservatorship/receivership will be made by the secretary and the FDIC, and will be informed by the recommendations of the Federal Reserve Board and the appropriate federal regulatory agency" if different from the FDIC, the Treasury said.
Moreover, the proposed legislation would permit the U.S. government to utilize a number of different forms of financial assistance in order to stabilize the institution in question.
It would create an appropriate mechanism to fund the appropriately limited exercise of the resolution authorities it confers.
This could take the form of a mandatory appropriation to the FDIC or through a scheme of assessments on the financial institutions.
The government would also receive repayment from the redemption of any loans made to the financial institution in question, and from the ultimate sale of any equity interest taken by the government in the institution.
Many of the regulatory changes that are being urged this year were first suggested by former Treasury Secretary Henry Paulson. His plan was set aside, however, as it came before a Democrat-controlled Congress in the last year of the Bush presidency and before the worst of the financial crisis hit.
MORE DEBATES AHEAD
While Geithner calls for the power to close troubled institutions, some critics call it pre-emptive bank nationalization and warn that it might do more harm than the good.
"The key problem would be finding adequate legal authority to justify the seizure without stretching regulatory discretion so far that it creates panic at other banks or a massive lawsuit," said Douglas Elliott, a researcher at the Brookings Institution.
The House Financial Services Committee could take up the new legislation as early as next week, as some Democrats supported the bill.
"I'm not prejudging the issue; I'm just saying at this point in time I want to look at it more carefully," House Majority Leader Steny Hoyer of Maryland told reporters.
However, Republican lawmakers expressed caution over the financial reform proposal, some accused the White House of "an unprecedented grab of power."
"Before that occurs, there ought to be a real debate about whether we should give that authority to the Treasury secretary," House Minority Leader John Boehner said.
"We do need to have some control over it. But I would hope we could all work together on making sure that that is done and done correctly at some point in the relatively near future," said Delaware lawmaker Michael Castle.
Under the draft bill, the Federal Reserve would act as systemic risk regulator while the Securities and Exchange Commission (SEC) would oversee consumer protection and transparency.
SEC Chairman Mary Schapiro said on Thursday that the current regulatory reform must guarantee the agency's independence in the future.
"The vision of the Congress when it created an independent SEC was to make sure that there was one agency of government focused single-mindedly and without dilution on the well-being of America's investors," said Schapiro in testimony prepared for a Senate hearing.
At a prime time news conference Tuesday, the second he has held since taking office in January, President Barack Obama also urged Congress to grant his government the new authority.
He said such power could have lessened the problems at AIG and that he anticipates "strong support" from the public and Congress for the new authority.
"We should have obtained it much earlier so that any institution that poses a systemic risk that can bring down the financial system, we can handle and we can do it in an orderly fashion, that quarantines it from other institutions," Obama said at the conference.
FDIC Chairwoman Sheila Bair expressed support for an expansion of her agency's responsibilities.
"Due to the FDIC's extensive experiences with resolving failed institutions and cyclical nature of resolution work, it would make sense on many levels for the FDIC to be given this authority working in close cooperation with the Treasury and the Federal Reserve Board of Governors," Bair said in a statement.