Geithner: The Regulatory War Ahead


A broad plan for federal oversight of hedge funds, private equity, and derivatives is drawing approval now. But wait till the details emerge

Fresh off his hit performance with the bank-rescue plan, Treasury Secretary Timothy Geithner seems to be on a roll. His broad proposal to overhaul regulation of whole swaths of the financial sector drew applause from most quarters on Mar. 26. Investors didn't seem at all unsettled by the prospect of intensified government oversight, as the Standard & Poor's 500-stock index rose 2.3% and Wall Street closed in on a second straight week of strong gains.

But the plan offered few specifics in many of the areas it addressed, from tougher regulation of complex financial derivatives to new rules for money-market funds. And Geithner steered well clear of some of the most contentious questions facing policymakers—the questions that are sure to turn agreement about broad principles into a pitched, possibly months-long political battle that pits financial interests against consumer advocates and one another.

"It's like with all these programs—the devil's in the details," said Kevyn Orr, a Jones Day attorney who previously worked for the Resolution Trust Corp. as it cleaned up after the savings and loan crisis in the early 1990s.

"Who's going to stand up and say, 'I don't like baseball, mom, and apple pie'?" Orr said. "But you go to Boston and New York, there's a whole lot of differences between Yankees and Sox."

Battles to Come

The Treasury Secretary promised specifics in coming weeks, including separate proposals addressing consumer protection, gaps in U.S. regulation, and ways to coordinate regulatory reform with other countries.

Those details are sure to throw into sharper relief the battles that lie ahead. Many of the proposals will bring some measure of scrutiny to corners of the financial markets that have gone for years without significant regulation, including private equity and hedge funds and the market for most financial derivatives. Defining which institutions should be deemed "systemically important"—whose failure could pose a risk not only to their own investors but to the financial system itself—and imposing stricter capital requirements on them will lead to jockeying among banks, insurers, and fund managers.

Tightening consumer protections—which many Democrats say would go a long way toward preventing another financial crisis—will likely mean restricting mortgage companies and credit-card lenders, among others. Closing regulatory gaps could spark disputes among government agencies and even congressional committees with overlapping or related jurisdiction. Lawmakers on the committees that oversee the Commodity Futures Trading Commission and the Securities & Exchange Commission won't be eager to cede authority to one another, for example.

Game Changers

In making his case to the House Financial Services Committee, Geithner called his proposal "not modest repairs at the margin, but new rules of the game." In focusing on systemic risk, he said regulators must be retooled to look beyond the soundness of individual institutions "but must also ensure the stability of the system itself."

To that end, Geithner renewed calls for a systemic-risk regulator with the authority to monitor and rein in large, interconnected financial companies, whether federal banks or hedge funds and other pools of private investments. He also called for beefing up the capital that big institutions must hold against their liabilities and requiring "leveraged private investment funds" over an unspecified size to register with the SEC and submit to closer scrutiny.

Geithner also said the government should establish rigorous oversight of the now-murky market for credit default swaps and other complex financial instruments, ensuring that most are traded through exchanges and central clearinghouses. He called for the SEC to "strengthen the regulatory framework" around money-market funds, and he repeated his call, made earlier in the week, to give the executive branch authority to dismantle or reorganize big financial institutions rapidly if they threaten the broader financial system.

Who Would Do the Regulating?

But Geithner didn't spell out what tougher money-market supervision might mean, or which agency would implement it. And in proposing a systemic-risk regulator, he steered clear of naming the agency that would receive broad new powers. While some, including House Financial Services Committee Chairman Barney Frank (D-Mass.), argue for giving the power to the Federal Reserve, others—including Senate Banking Committee Chairman Christopher Dodd (D-Conn.)—are cooler to the idea. Dodd has questioned whether the additional duties would distract from the Fed's existing responsibility for monetary policy and regulating bank holding companies.

Moreover, regulating "leveraged private investment funds" could be tricky. A private equity fund could decide that "from now on, we won't call ourselves a private investment fund, we'll call ourselves a private investment association," Orr noted.

Geithner acknowledged the gaps in his testimony, saying he wanted to concentrate on the substance of the proposals "rather than the complex and sensitive questions of who should be responsible for what."

Beyond laying the foundation of a regulatory reform plan, Geithner continued to make the case for the most detailed part of the proposal, so-called resolution authority that would give the government the ability to dismantle big financial institutions whose failure threatens the entire financial system or the economy.

Something for the G-20

The broader plan, as sketchy as it was, also gives President Barack Obama something to bring to next week's meeting with the heads of other major economies—many of whom have said their top priority is coordinating global financial regulation. Still, the proposal as it stands is unlikely to be detailed enough for European leaders.

And then there's the domestic political angle: Amid mounting public frustration over the U.S. financial bailout, proposals to limit, and potentially dismantle, dangerous financial institutions are likely to resonate, to the Administration's benefit. "They look like they're punishing the bad actors," says Daniel Clifton, a policy analyst with Strategas Research Partners. "The hard decisions will be made down the road."

That populist edge could complicate the usual Wall Street defense mechanism against regulations: sending a flood of lobbying money to sympathetic members of the House and Senate. But overall, Clifton says, little in Geithner's proposal is surprising. "Is it going to be harder for financials to make a profit? Yes," he says. But considering the depth of the anger over the financial crisis, "that was a given," he added.

Federal Regulation of Insurers?

In fielding questions from lawmakers, Geithner did step into one minefield: He said he saw "a good case for an optional federal charter for insurance companies"—immediately drawing praise from large financial institutions, many of which have long lobbied for an alternative to state-by-state regulation of insurance products. But such a move is less popular with many insurance agents and brokers—historically a potent lobbying force—as well as with the state regulators and legislatures that currently oversee the insurance industry.

Ultimately, given the consensus in Washington that flawed regulation helped deepen the ongoing financial crisis, many of the reforms Geithner proposed will come to fruition in one form or another. And that's significant in itself, notes Scott Talbott, a lobbyist for the Financial Services Roundtable, which represents large financial firms.

"There's lots more to be done," Talbott said. "But by the time we're done it will be a sweeping reform."


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