Obama administration to overhaul bank rules

Bloomberg

The Obama administration is preparing an overhaul of U.S. banking rules that would force financial companies to keep more cash on hand in case their trading bets go wrong.

Treasury Secretary Timothy Geithner told lawmakers Tuesday that changes will include "strong oversight, including appropriate constraints on risk-taking." Federal Reserve Chairman Ben S. Bernanke said the case of American International Group showed the "intense problem" of trading with insufficient capital to guard against losses.

"You’ll see less risk assumed, and that might lead to lower profits on average," said Robert Parry, who served as president of the Federal Reserve Bank of San Francisco from 1986 to 2004. "There’s no doubt that the administration and regulators" are going to get banks to treat risk differently.

The comments foreshadowed what may become the biggest overhaul to U.S. banking rules since the 1930s. To prevent the nation from losing its share of the global financial industry, the administration will also need to ensure that regulators abroad take similar measures, Geithner said.

"Without that, there is a risk that capital will move, business will shift from the United States, and we’ll end up with a weaker system overall," the Treasury chief said at a House Financial Services Committee hearing Tuesday.

Geithner will offer more details on the administration’s plans at the same House panel today. President Barack Obama will present the outline to his counterparts in the Group of 20 developed and emerging nations at an April 2 summit in London.

Call for new powers

The Treasury chief also called for new authority to seize and wind down failing financial companies in the aftermath of the AIG rescue, which has ballooned to $182.5 billion from an initial $85 billion in September. Obama said in a news conference late Tuesday that he expects there will be "strong support" for the proposal.

The powers would allow the Treasury secretary to establish a conservatorship or receivership for a failing firm, including control over the company’s operations and the ability to impose partial losses on its creditors.

While the Federal Deposit Insurance Corp. has the ability to take over failing deposit-taking firms and wind down their assets, no such authority exists for financial firms that are not classified as banks, such as AIG or a hedge fund with extensive links throughout the banking system.

"AIG highlights the urgent need for new resolution procedures for systemically important non-bank financial firms," Bernanke said.

Barney Frank, the chairman of the House panel, said he supported the call for legislation to put nonbanks "out of their misery."

The authority will "allow us to avoid all or nothing" - referring to the bailout for AIG and the decision by regulators in September to allow Lehman Brothers Holdings to file for bankruptcy, worsening the financial crisis.

Geithner separately pledged to lawmakers that his plan to shore up the financial system "will work," provided it has sufficient resources. Without committing to request more money for the $700 billion rescue fund, he said that "we’ll need to work with Congress to make sure we can do this on a scale that’s going to make it work."

The Treasury plan uses $75 billion to $100 billion to help finance a $500 billion initiative to help private investors buy the distressed loans and securities on banks’ balance sheets.

Hedge funds

The strategy would also allow hedge, pension and mutual funds to sell mortgage-backed securities to investors financed by the Treasury and Fed. All market participants will be eligible to participate, an administration official said Tuesday.

During the hearing, Representative Edward Royce, a California Republican, warned against government support undermining incentives and creating an unfair playing field.

"At the end of the day, we undermine market discipline because we telegraphed the message to the market that the government is behind these institutions," Royce said.

Geithner said regulators and lawmakers need to "bring these markets into an oversight framework that better provides better protection for the financial system."

It is "critically important" that companies that invest in products such as credit default swaps "hold enough capital or reserves or cushions against the risk those instruments present."

Bernanke said that "there was a particularly intense problem at AIG because they were essentially using these swaps to sell insurance against which they neither had capital nor did they have hedging, and so when the insured event occurred, there were enormous losses."

Both Bernanke and Geithner favored a consolidated regulator that can look at financial risk across the system. The two reiterated their opposition to bonus payments for the AIG financial-products division, with Bernanke saying he had initially sought a lawsuit to halt them. "Regulators must apply standards, not just to protect the soundness of individual institutions, but to protect the stability of the system as a whole," the Treasury chief said.