CQ TODAY ONLINE NEWS
– BANKING & FINANCIAL SERVICES
Updated June 17, 2009 – 12:54 p.m.
Fed at Center of Obama Financial Plan
By Phil Mattingly, CQ Staff
President Obama’s expansive proposal to reshape the battered financial system, set to be unveiled Wednesday afternoon, centers on expanding the power of the Federal Reserve to regulate the nation’s largest financial institutions, as well as creating two new regulators with broad authority over key sectors of the industry.
The administration hopes the proposal, much of which will need to be approved by Congress, will change the face of the financial system, preventing the possibility of another economic collapse like the one that has shaken markets and consumers over the past year, a senior administration official said Tuesday night.
“We seek to create a framework in which markets can function freely and fairly, without the fragility in which normal business cycles bring the risk of financial collapse; a system that works for businesses and consumers,” Obama said in remarks prepared for delivery at the White House.
But the plan will be scrutinized — and probably altered significantly — by lawmakers in both parties, setting up major battles as the legislation starts to move forward.
Treasury Secretary Timothy F. Geithner will arrive on Capitol Hill Thursday to testify on the plan in front of the banking committees in both the House and Senate. Obama acknowledged the debate ahead.
“These proposals reflect intensive consultation with leaders in Congress,” he said. “. . . There are also those who will say we are going too far. But the events of the past few years offer ample testimony for the need to make significant changes.”
The first battle expected to play out in Congress will surround the designation of the Fed as the primary overseer of a small number of “systemically risky” financial institutions whose collapse would threaten the broader economy. Such institutions would be subject to closer federal supervision and more stringent capital requirements, and the Fed would have the ability to wind them down in the event of their failure.
The administration proposal “would compel these firms to internalize the costs they could impose in the event of failure,” a draft of an administration summary of the overhaul plan stated.
“The prudential standards [for the institutions] — including capital, liquidity and risk management standards — should be stricter and more conservative than those applicable to other financial firms to account for the greater risks that their potential failure would impose on the financial system.”
Specifics as to how the systemically risky institutions — deemed “Tier 1” institutions in the draft — would be identified will be included in legislation that the administration will soon send to the Hill.
Under Obama’s proposal, the Fed would be “authorized to collect periodic and other reports from all U.S. financial firms that meet certain minimum size thresholds.”
The Fed also would be given clear authority over payments, deal clearings and financial settlement systems.
But even as the Fed’s mandate in those areas would be expanded, its powers would be scaled back elsewhere, including some of the tools the central bank used to bail out the financial system in the past year.
The Fed would be required to propose recommendations by Oct. 1 “to better align its structure and governance with its authorities and responsibilities.”
The core component of the Fed’s emergency powers — a statute that enables it essentially to lend to any institution, at any time, should circumstances be deemed “unusual and exigent” — would first require the written approval of the Treasury Department.
New Regulators
Much of the Fed’s consumer protection rulemaking authority would be given to a new Consumer Financial Protection Agency. The SEC, on the other hand, would get beefed up investor-protection power.
Obama’s proposal also would create a council of regulators that would be led by the Treasury Department and would replace the President’s Working Group on Financial Products. The council would have “the authority to gather information from any financial firm and the responsibility for bringing emerging risks to the attention of regulators with the authority to respond,” the draft summary states.
And the proposal would make a major effort to shine some light on the “shadow banking system” — hedge funds, private equity firms and private derivatives trades whose relative secrecy leaves many uneasy after the economic turmoil of the past year — though it stops short of some of the regulations several lawmakers have demanded.
Left Out
Despite the historic size and scope of the administration’s plan, several aspects that many observers thought would be put in play were largely absent from the draft summary.
Given the fall of insurance giant American International Group Inc., in September 2008, which cost taxpayers billions of dollars in bailout funds, many were expecting a complete overhaul of the insurance industry — and possibly the creation of an optional federal charter to split regulation between federal and state entities.
As it stands now, insurance companies are primarily regulated at the state level. But with many insurance providers expanding their operations and developing increasingly complex financial products, lawmakers are considering whether to make regulatory changes.
The administration will propose the creation of a central insurance information agency, stationed at Treasury, that would “be responsible for monitoring all aspects of the insurance industry,” the draft proposal states. The office would be focused on gathering information about the industry and be responsible for identifying the emergence of any problems or gaps in regulation that could contribute to a future crisis, making corrective recommendations to the Fed.
It falls far short of what some lawmakers — and outside observers — were looking for, but it is an issue that could still be addressed later this year.
House Financial Services Chairman Barney Frank , D-Mass., said Tuesday that his committee would consider a broader overhaul of the insurance industry in a separate legislative effort.
Obama’s proposal also avoids any direct changes to the way government-run mortgage giants Fannie Mae and Freddie Mac operate. The two companies, placed into conservatorship by the federal government last fall, have become a hot-button topic for Republicans and Democrats alike, who worry about the political influence and eventual systemic risk the companies hold onto.
But since the companies were nationalized, they have become central to the Obama administration’s effort to fight the foreclosure crisis that has swept through the country since 2006. That has left the companies even larger and more difficult to wind down.
The Obama proposal calls for Treasury and the Department of Housing and Urban Development to launch a “wide ranging initiative” to develop recommendations for the future of the companies. Those recommendations will be reported to Congress when the president’s fiscal 2011 budget proposal is released.
First posted June 17, 2009 9:55 a.m.
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