Treasury Secretary Timothy Geithner asked Congress on Thursday for sweeping powers to regulate the kinds of investments that have caused global financial markets to implode, saying they were necessary to restore confidence in the system.
Appearing before a panel of the House Financial Services committee, Geithner called for comprehensive reform to fix a system that had fueled economic prosperity in the past but also "attracted fraud on a dramatic scale."
He said what was needed was "not modest repairs at the margin, but new rules of the game."
The Treasury secretary's proposal, which will require congressional approval, would very likely represent the single largest expansion of federal authority over the financial system since the Great Depression.
In requesting the unprecedented powers to seize failing nonbank financial institutions and regulate credit default swaps and other derivatives, Geithner told lawmakers that such products and institutions "should be regulated for the economic function they provide and the risks they present, not the legal form they take."
"Confidence in the overall financial system, in the protections it is supposed to afford for investors and consumers, has eroded," he said. "These financial pressures have intensified the recession now under way around the world."
Geithner laid the groundwork for the plan to overhaul the financial regulatory system earlier this week in a joint appearance on Capitol Hill with Federal Reserve Chairman Ben Bernanke. On Thursday, he outlined specifics. To deal with systemic risk, he said, the government needs:
• A "single entity" to oversee a requirement that "firms build up capital during good economic times so they have a more robust protection against losses in down times." He also said that regulators should issue "standards for executive compensation practices across financial firms" based on "long-term performance ... not short-term profits."
• Leveraged private investment funds, such as hedge funds, with assets over a certain threshold, to register with the Securities and Exchange Commission.
• A "single entity" to consult with regulators to enforce a broad and clear authority of "oversight, protections and disclosure" for the derivatives market, including credit default swaps. Included is a requirement that "all nonstandardized derivatives contracts be reported to trade repositories and be subject to robust standards for documentation and confirmation of trades, netting, collateral and margin practices, and close-out practices."
• The Securities and Exchange Commission to "develop strong requirements for money market funds to reduce the risk of rapid withdrawals of funds."
Geithner reiterated the administration's call for a "resolution authority" to oversee financial institutions not already covered by the Federal Deposit Insurance Corp. Such an authority would require the president to sign off on a recommendation from the Treasury secretary, the Federal Reserve Board and the FDIC to seize a failing institution whose survival was deemed vital to U.S. economic interests.
"Let me be clear: The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers from losses must end," he said.
The prototypical example of such an institution is insurer American International Group Inc., whose woes sparked panic among policymakers and investors and which has so far received $180 billion in federal bailout money. AIG traded heavily in unregulated credit default swaps — a $60 trillion global market of contracts that insure against the default of financial instruments such as bonds and corporate debt.
Hedge funds, vast pools of capital holding an estimated $1.5 trillion in assets, have also operated mostly outside government supervision. As the financial crisis deepened last fall, hedge funds' short selling — essentially betting the market will go down — was cited as a prime reason for the pounding taken by stocks and bonds.
It resulted in a complex financial tangle that spanned the globe and threatened to bring down the world financial system, Geithner said.
"Our system is wrapped today in extraordinary complexity, but beneath all that, financial systems serve an essential and basic function," he told lawmakers. "Financial institutions and markets transform the earnings and savings of American workers into the loans that finance a home, a new car or a college education."
But some lawmakers expressed incredulity that any new federal authority could keep future financial crises at bay. "Forgive me if I am a skeptic," Rep. Scott Garrett (R-NJ) told Geithner, "when I hear that if we only have a systemic regulator it will never happen again."
The administration, which wants Congress to act quickly on the new regulatory agenda, sent lawmakers a bill on Wednesday dealing with the expanded powers to take over failing financial institutions. Rep. Barney Frank (D-MA), the chairman of the House Financial Services Committee, has said it could be considered as soon as next week.
Material from The Associated Press was used in this report.