Against a congressional backdrop of bailout fatigue, the Obama administration is ramping up its outreach to pass legislation to revamp the nation's financial regulatory system, especially over the issue of unwinding financial firms whose collapse would threaten the broader economy.
The drive to establish a resolution authority -- in which the federal government can take over major firms, unwind their assets and get them back into the private market -- has taken on a greater sense of urgency as congressional critics charge that it would establish a permanent bailout system akin to the Troubled Asset Relief Program. TARP is slated to expire at year's end but can be renewed for another 10 months by the Treasury Department.
House Financial Services Chairman Committee Barney Frank, D-Mass., has even said that legislation would take a "death panel" approach to firms such as American International Group, which has received a federal line of credit worth more than $180 billion.
The administration is working with congressional Democrats to craft a bill that can withstand charges that it would lead to another AIG-type situation. "The most important thing to do is make sure banks and investors do not live with the expectation the government is going to bail them out. We have to make sure we build into our system the capacity to let institutions fail without igniting an inferno," Treasury Secretary Tim Geithner said on Tuesday in an interview with congressional reporters.
The administration has proposed a resolution system for large financial firms similar to what the FDIC does for failed banks. Under the proposal, the FDIC would be in charge of unwinding all firms except broker-dealers, which would be handled by the SEC. Taking over a firm would require a two-thirds vote by the Federal Reserve Board and the board of either the FDIC or the SEC, as well as the approval of Treasury.
Under the Treasury proposal, the holding companies would be required to have more conservative capital standards to cover unanticipated losses for the resolution. In addition, Treasury would be granted the authority to provide a line of credit to the failed firm, to be repaid after the firm was placed back into the private market.
Treasury has ruled out establishing a front-end fund to pay for the unwinding, an idea that would gain no congressional traction. "Resolution authority is not for savings banks; it is used to dismember, unwind, restructure, close institutions with less collateral damage and less risk to the taxpayer," Geithner said. He added the move to regulate the derivatives market would force a dramatic change.
"Our proposal is a revolution in the regulation of derivatives," he said. The Obama administration has proposed to force most standardized derivatives -- such as options, swaps and futures -- on to exchanges and into clearinghouses, which stand behind all trades and guarantee payment. It would still allow some to be made over the counter through bilateral trades, but those transactions would come with higher capital costs and additional reporting requirements.