White House

Geithner outlines regulatory changes for financial system

WASHINGTON — The Treasury Department unveiled proposed legislation Wednesday that would give it broad powers to shut down big financial institutions, the opening act to overhaul regulation of the nation's troubled financial system and a move that could pave the way for nationalizing banks.

Treasury Secretary Timothy Geithner will ask Congress on Thursday to give him powers similar to those that allow the Federal Deposit Insurance Corp. to seize smaller banks.

The lack of sufficient seizure powers is one reason that taxpayers have been asked to bail out troubled insurer American International Group, whose financial operations were deemed too big to fail last September without endangering the global financial system.

"The legislation would authorize the U.S. government, in appropriately limited circumstances, to intervene at the appropriate time to avert the systemic risks posed by the potential insolvency of a significant financial firm," a Treasury statement Wednesday said of the legislation, which the House Financial Services Committee will consider on an expedited basis.

While Geithner calls this the power to close troubled institutions, some critics call it pre-emptive bank nationalization and warn that it might do more harm than 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," Douglas Elliott, a researcher at the center-left Brookings Institution, said in a paper published Wednesday.

Geithner's push for broader powers is the opening move in what's expected to be a yearlong drive toward revamping federal regulation of the U.S. financial system. Rather than moving a single broad package to overhaul the system, the work will be done in pieces.

Taking questions Wednesday in New York from members of the Council on Foreign Relations, Geithner shot down the idea that an overhaul should wait until the financial crisis has passed.

"We're going to do whatever it takes to get through the crisis, but we want to get started now" on regulatory changes, he said, promising "prudential" changes that will limit how much borrowed money financial firms can invest, a practice called leveraging. He also hinted at new requirements for banks to have more cash on hand to weather storms.

Some changes will be made through the tax code. President Barack Obama already has proposed taking away the preferred tax status enjoyed by private-equity firms and hedge funds, which invest pools of money for the ultra-wealthy. Private equity and hedge fund managers are compensated through earnings that are taxed at the long-term capital gains rate of 15 percent, instead of the 35 percent rate that applies to the highest earners of ordinary income.

Other changes are likely to be slower and broader, and they could eliminate some government agencies through mergers of bank regulators. There also seems to be widespread support for a single agency — perhaps the Federal Reserve Board — to have the authority to act as a "super-regulator," empowered to act against any threat it sees to the U.S. financial system.

The idea of a systemwide risk regulator addresses a central shortcoming. Today's crisis was brought on partly because many agencies had some regulatory authority over parts of the system but financial firms were able to exploit the gaps in regulation. They then took excessive risks that contaminated the entire financial system.

Many of the regulatory changes that are being urged this year were first suggested in a blueprint that former Treasury Secretary Henry Paulson offered last year. His plan was set aside, however, as it came before a Democratic-led Congress in the last year of the Bush presidency and before the worst of the financial crisis hit.

The fight for piecemeal regulatory changes begins Thursday when Geithner pushes his plan for resolution authority, which would broaden the range of companies that can be taken over.

"This would include bank and thrift holding companies and holding companies that control broker-dealers, insurance companies and futures commission merchants," the Treasury statement said, pointing to big financial companies that now escape the full reach of regulators.

Many of the companies that took outsized risks were investment banks such as Goldman Sachs and Morgan Stanley, which aren't subject to the same scrutiny as commercial banks. These investment banks have since petitioned to become bank holding companies, making them eligible for taxpayer bailout money. Under Geithner's proposal, they could be subject to seizure by the government just as smaller community banks are now.

That authority also would allow regulators, after seizing banks, to cut compensation to executives that mismanaged their firms and to force investors to take losses.

To seize a company, the treasury secretary would need approval from the Federal Reserve Board and the regulatory agency with closest supervision powers.

Vincent Reinhart, a former top Fed economist, said the implementation of the legislation was likely to borrow heavily from last year's seizure by the Treasury Department of quasi-government mortgage giants Fannie Mae and Freddie Mac. They were placed in conservatorship, continuing to operate privately but with government supervision that stops short of outright nationalization.

"I think it's tough to roll out encompassing legislation in such a short time frame. They've got to work with what they've got," said Reinhart, who's now a fellow at the American Enterprise Institute, a conservative policy-research organization. "That will bring back the notion of conservatorship and give somebody . . . authority to roll up institutions."


Treasury's proposed legislation

Brookings paper

Transcript of Geithner's talk at the Council on Foreign Relations


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