The push to remake the financial industry’s rules of the road in hopes of softening future boom-and-bust cycles gathered momentum this week with Treasury Secretary Timothy Geithner urging Congress Thursday to create new systems to monitor and control risks.
So far in the financial crisis, Washington has acted mainly to contain the immediate damage to the economy. But any deeper fixes could also yield results quickly.
By signaling a receptivity to increased regulation – a key European demand – the announcement might strengthen President Obama’s ability to nudge Germany and other nations on a US priority at next week’s meeting of the Group of 20 leaders: expanding government spending as an economic stimulus.
Federal agencies would also have new authority to intervene at large, troubled financial institutions like AIG if parts of Mr. Geithner’s plan are enacted into law.
Longer term, clarifying potential reforms could lift economic confidence.
Among the controversial points that Congress will wrestle with: What body should be empowered to be the watchdog of major risks to the financial system?
One leading candidate for the job is the Federal Reserve. But the Fed already has the major mission of setting monetary policy – and being a so-called lender of last resort in financial crises. Also, the Fed is coming in for its share of criticism in Congress lately for some of its actions during the crisis.
An alternative is to set up a new entity to do the job. Either way, this new role would come on top of – not as a replacement for – other agencies overseeing parts of the financial industry.
Appearing before the House Financial Services Committee on Thursday, Mr. Geithner outlined key goals for regulatory reform.
“The system proved too unstable and fragile, subject to significant crises every few years, periodic booms in real-estate markets and in credit, followed by busts,” Geithner said. “These failures have caused a great loss of confidence in … a system that over time has been a tremendous asset for the American economy.”
He outlined four broad areas reforms will cover. They include protecting consumers and investors, eliminating gaps in the regulatory structure, and enhancing the coordination of rules in a more global economy.
The fourth area of reform, addressing “systemic risk,” was his focus Thursday. He proposed:
•Naming a single entity to track systemic stability across all sectors of financial activity.
•Creating a resolution mechanism for important nonbank firms, so that they can be assisted or shut down, if needed, outside of traditional bankruptcy.
•Tightening the capital requirements for large financial firms so that they would rein in cyclical tendencies. During a boom, firms would have to set aside more reserves, as a way to curb excesses and provide a cushion for bad times.
•Requiring large hedge funds and other private-investment funds to register with the Securities and Exchange Commission (SEC) and be more transparent to regulators regarding their leverage – or borrowing – and risk.
•Establishing oversight and protections for investments known as derivatives, such as the credit-default swaps that fueled AIG’s collapse.
•Crafting SEC rules to make money-market funds safer, reducing the risk that account holders would panic or face losses in a crisis.
Geithner is the point man in a larger effort by the Obama administration to clarify these goals. Other officials, including Fed Chairman Ben Bernanke, have urged similar steps this month. Mr. Bernanke said the AIG failure could have been handled in a less costly way had the government had the authority to deal with troubled nonbank firms the way the the Federal Deposit Insurance Corp. (FDIC) deals with failed banks.
If other firms falter, such authority might prove useful to regulators before this recession is over.
Regulatory reform can be viewed as the final piece of an overall plan that, Geithner says, will succeed over time in ending the credit crisis. When a congressman asked him earlier this week about the whether a Plan B was needed, Geithner responded confidently.
“This plan will work,” he said. “We just need to keep at it.”
Where this fits in
There are other parts of the plan, which have been announced in recent weeks. They include reviving the housing market by preventing foreclosures and keeping interest rates low, investing in weak banks so they have enough capital to cope with loan losses, and developing a public-private partnership to buy troubled bank assets that have been a cause of investor uncertainty.
After months of worsening economic news, some recent data have made economists optimistic that the economy may hit bottom later this year. Housing-market news has been less grim, and buyers may be encouraged not only by a first-time buyer’s tax credit, but also by mortgage rates that this week fell to historic lows below 5 percent on 30-year fixed-rate loans.
Meanwhile, the stock market has risen strongly this month, and consumer spending has shown signs of stabilizing after a winter plunge.
But it remains unclear whether the Geithner plan will work, and whether banks will be healthy enough to help fuel a strong economic recovery.
Mr. Wyss of S&P, for one, doesn’t share Geithner’s level of confidence that current policies will be effective. But “I’m feeling a little more confident today than I was a month ago,” he says.
Financial experts say that moves to improve the regulatory structure should help the functioning of an industry that plays a vital role in the economy – and that has proved subject to abuses.
One key step, they say, is to make sure that rules do better at covering broad types of activity across a range of firms.
The worst excesses in mortgage lending, for example, arose among less-regulated mortgage brokers with mainstream banks playing a supporting or follow-on role.
Another key could be to reform how bankers are paid and given incentives. Geithner made brief reference to compensation, but this is a tricky issue for Congress to address. The goal might be to set guidelines so that pay depends on managing and reducing risks as well as achieving profit goals.