Treasury Secretary Timothy Geithner went to Capitol Hill on Thursday with expansive plans to reduce "systemic risk" in the financial system. He called for new rules and better referees. And he was met with skepticism, particularly from Republicans.
RENEE MONTAGNE, host:
It's MORNING EDITION from NPR News. Good morning. I'm Renee Montagne.
STEVE INSKEEP, host:
And I'm Steve Inskeep.
We're finishing another week of changes to the financial system. Treasury Secretary Timothy Geithner unveiled not one, but two new plans.
MONTAGNE: In a moment, we'll ask the presidential advisor about the plan to buy toxic assets. First we'll hear the proposal to prevent the next crisis. Geithner wants to change the rules, to make it harder for one failed institution to wreck the economy. Here's NPR's David Welna.
DAVID WELNA: As House Financial Services Committee Chairman Barney Frank was quick to point out yesterday, anyone who wonders whether the current financial regulatory system needs fixing, should consider two major financial institutions.
Representative BARNEY FRANK (Democrat, Massachusetts; House Financial Services Committee Chairman): And the two glaring examples are Lehman Brothers, where nothing was done and AIG, where everything was done. And I believe we are looking for an alternative method to avoid those two polar extremes.
WELNA: The problem, Treasury Secretary Geithner told Frank's panel, is that the federal government right now does not have the kinds of regulatory tools it needs to avoid those two extremes.
Secretary TIMOTHY GEITHNER (Department of Treasury): To address this, we'll require comprehensive reform, not modest repairs at the margin, but new rules of the game. And the new rules must be simpler and more effectively enforced.
WELNA: Geithner had six proposals for greater systemic stability. First, he'd want a single government entity to watch over major financial institutions. Second, he'd require bigger capital reserves for institutions that could pose a risk to financial stability. Third, large private hedge funds would have to register, for the first time, with the Securities and Exchange Commission. Fourth, exotic financial products, such as credit default swaps, would have to be traded and regulated through a central clearing house. Fifth, he'd have the SEC tighten roles for money market funds.
And finally, he called for powers to seize financial institutions beyond banks. Scott Garrett, the panel's top Republican, reminded Geithner, this is not the first time federal authorities have tried slapping on new regulations to fix a financial fiasco.
Representative SCOTT GARRETT (Republican, New Jersey): So, forgive me if I'm still a skeptic when I hear, if we only have a systemic regulator, that this will never happen again.
WELNA: But Geithner said he would make no such promises.
Sec. GEITHNER: Nothing we do here today, over the next six months, we'll offer the prospect of preventing all future financial crises. We can make sure that when they happen in the future, we can act more quickly, more effectively, to contain the damage, to put a firebreak around the most - weaker parts of the system.
WELNA: Such a firebreak he said, would keep the flames from one failing entity from leaping over and burning more prudent and responsible players in the financial system. But Illinois Republican, Donald Manzullo was hardly convinced. He said he was not at all comfortable with the idea of federal authorities deciding to take over financial firms.
Representative DONALD MANZULLO (Republican, Illinois): But you realize how radical your proposal is?
Sec. GEITHNER: It's not a radical proposal.
Rep. MANZULLO: Oh this is absolutely. You're talking about seizing private businesses and you don't consider that to be radical?
Sec. GEITHNER: No this is a prudent, carefully designed proposal to protect our financial system from the…
Rep. MANZULLO: If it's prudent and carefully designed, Mr. Secretary, then you'd have the answers to some of my questions, such as what size business would be subject to this.
WELNA: Geithner assured Manzullo, he simply did not know at this point, how many American firms might come under such systemic regulation. The larger point, he said, is to avoid having the American taxpayer on the hook for companies deemed too big to fail.
Sec. GEITHNER: The most simple way to frame it is capital, capital, capital. Capital sets the amount of risk you can take overall. Capital assures you have big enough cushions to absorb extreme shocks. You want capital requirements to be designed so that, given how uncertain we are about the future of the world, given how much ignorance we fundamentally have about some elements of risk that, there is a much greater cushion to absorb loss and to save us from the consequences of mistaken judgment and uncertainty in the world.
WELNA: And because market forces alone won't ensure firms have enough capital reserves, Geithner added, standards have to be imposed through regulation. His plan should please the European allies, President Obama meets with next week at the G-20 summit. The United States' problem, they say is too little regulation.
NPR transcripts are created on a rush deadline by a contractor for NPR, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of NPR’s programming is the audio.
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.