The Treasury Department has released new details about its plans for regulation of the financial system. The framework for reform includes creating a single regulator to manage system risk, increasing capital and risk management requirements for systemically important firms, requiring hedge funds above a certain size to register and regulation and oversight of the derivatives market.
The talk of establishing a systemic risk regulator to oversee all financial institutions has gained increased attention in recent weeks, as Congress has focused on the government's involvement in AIG. The Treasury Department says it wants to give "a single entity the ability to supervise, examine, and set prudential requirements for these critical parts of our financial system."
How does Treasury determine which firms are "critical parts of our financial system"? Here are the characteristics:
the financial system's interdependence with the firm
the firm's size, leverage (including off-balance sheet exposures), and degree of reliance on short-term funding
the firm's importance as a source of credit for households, businesses, and governments and as a source of liquidity for the financial system.
Though there is still no word on which agency will get the job, Senate Banking Committee Chairman Christopher Dodd recently proposed creating a council of the Fed, the Federal Deposit Insurance Corp. and the Office of Comptroller of the Currency to keep a single agency from having too much power. The Bush administration originally proposed that the Federal Reserve take over the role, but mounting criticism of the Fed's role in AIG has turned some lawmakers against the idea.
Here's the take from Calculated Risk:
Imagine if the Federal Reserve had been the "systemic-risk regulator" during the bubble.
According to Greenspan in 2005 "we don't perceive that there is a national bubble", just "a little froth", and even in March 2007 Bernanke said "the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained".
How would a systemic-risk regulator help if they miss the problem?
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