Treasury Secretary Timothy Geithner unveiled on Mar. 26 details of the Obama Administration's proposals to strengthen regulation in the financial sector, including new oversight of hedge funds and derivative financial products such as credit default swaps. The proposal also expands on the Administration's call for a broad "resolution authority" that would allow orderly dissolution of insolvent firms' whose failure would threaten the stability of the financial system.
In testimony prepared for an appearance before the House Financial Services Committee, Geithner said the current economic crisis shows that the financial system is too unstable and fragile, and requires reform at its core. "Financial products and institutions should be regulated for the economic function they provide and the risks they present, not the legal form they take," Geithner said. "We can't allow institutions to cherry-pick among competing regulators, and shift risk to where it faces the lowest standards and constraints."
Geithner's proposals center on systemic risk—the potential for one or a few large and closely intertwined institutions to seriously harm the U.S. economy as they collapse. In his prepared remarks, Geithner said the Administration will tackle other issues "in the coming weeks," including consumer and investor protection, "eliminating gaps in our regulatory structure," and global regulatory coordination.
More Conservative Capital Requirements
Geithner called for a "single entity with responsibility for systemic stability over major institutions and critical payment and settlement systems and activities" and "more conservative capital requirements" for firms that pose risk to the financial system. He also said large hedge funds should be required to register with the Securities & Exchange Commission and sought more oversight and transparency in the over-the-counter derivatives market, including moving standardized products to a central clearinghouse.
Geithner also called for the SEC to "strengthen the regulatory framework" around money-market funds—noting that the failure of one large fund last fall to maintain its $1-a-share price led to a freezing up of short-term credit markets—but he provided little detail as to what that additional regulation should include.
The Mar. 26 proposals don't go much beyond what many analysts expected, and key congressional leaders have already held hearings and begun staking out positions on most, including the creation of a systemic-risk regulator and the tighter regulation of credit default swaps and other derivatives. One key element—giving the government tools to dismantle failing institutions that threaten the economy—was laid out in some detail in legislation proposed earlier in the week.
The testimony sets the stage for Obama's trip to the G20 summit in London next week. There, European countries plan to emphasize the importance of coordinating regulatory reform internationally, to prevent "regulatory arbitrage" as financial institutions gravitate toward laxer regulation.
But the two regions have potentially troublesome differences: In his prepared testimony, Geithner called for requiring hedge funds and similar investment funds to "register with the SEC to provide greater capacity for protecting investors." But European officials want to go further, and regulate such funds more like banks.
Notably absent from the proposal on establishing a systemic risk regulator: the agency that should be granted the new powers. House Financial Services Committee Chairman Barney Frank (D-Mass.) has publicly leaned toward giving the Federal Reserve those powers, but Senate Banking Committee Chairman Christopher Dodd (D-Conn.) has been less receptive to giving the Fed the additional authority. In his testimony, Geithner said he wanted to concentrate on the substance of the proposals "rather than the complex and sensitive questions of who should be responsible for what."