WASHINGTON – Treasury Secretary Timothy Geithner plans to propose today an expansion of federal authority over the financial system, breaking from an era in which the government stood back from financial markets and allowed participants to decide how much risk to take in the pursuit of profit.
The Obama administration’s plan, described by several sources, would extend federal regulation for the first time to all trading in financial derivatives and to companies including large hedge funds and major insurers such as American International Group. The administration also will seek to impose uniform standards on all large financial firms, including banks, an unprecedented step that would place significant limits on the scope and risk of their activities.
Most of these initiatives would require legislation.
Geithner plans to make the case for the regulatory reform agenda in testimony before Congress this morning, the sources said, and he is expected to introduce proposals to regulate the largest financial firms. In coming months, the administration plans to detail its strategy in three other areas: protecting consumers, eliminating flaws in existing regulations and enhancing international coordination.
The testimony will not call for any existing federal agencies to be eliminated or combined, according to the sources, who spoke on condition of anonymity. The plan focuses on setting standards first, leaving for later any reshaping of the government’s administrative structure.
The nation’s financial regulations are largely an accumulation of responses to financial crises. Federal bank regulation was a product of the Civil War. The Federal Reserve was created early in the 20th century to mitigate a long series of monetary crises. The Great Depression delivered deposit insurance and a federally sponsored mortgage market. In the midst of a modern economic upheaval, the Obama administration is pitching the most significant regulatory expansion since that time.
An administration official said the goal is to set new rules of the road to restore faith in the financial system. In essence, the plan is a rebuke to raw capitalism and a reassertion that regulation is critical to the healthy function of financial markets and the steady flow of money to borrowers.
The government also plans to push companies to pay employees based on their long-term performance, curtailing big paydays for short-term victories. Long-simmering anger about Wall Street pay practices erupted last week when the administration disclosed that AIG had paid $165 million in bonuses to employees of its most troubled division, despite losing so much money that the government stepped in with more than $170 billion in emergency aid.
The administration’s signature proposal is to vest a single federal agency with the power to police risk across the entire financial system. The agency would regulate the largest financial firms, including hedge funds and insurers not currently subject to federal regulation. It also would monitor financial markets for emergent dangers.
Geithner plans to call for legislation that would define which financial firms are sufficiently large and important to be subjected to this increased regulation. Those firms would be required to hold relatively more capital in their reserves against losses than smaller ones, to demonstrate that they have access to adequate funding to support their operations, and to maintain constantly updated assessments of their exposure to financial risk.
The designated agency would not replace existing regulators but would gain the power to compel firms to comply with its directives. Geithner does not plan to identify which agency should hold those powers, but sources familiar with the matter said that the Federal Reserve, widely viewed as the most obvious choice, is the administration’s favored candidate.
Hand in glove with this expanded oversight, the administration also is seeking the authority to seize these large firms if they totter toward failure.
Under current law, the government can seize only banks.
The administration Wednesday detailed its proposed process, under which the Federal Reserve Board, along with any agency overseeing the troubled company, would recommend the need for a seizure. The Treasury secretary, in consultation with the president, then would authorize the action. The firm would be placed under the control of the Federal Deposit Insurance Corp. The government also would have the power to take intermediate steps to stabilize a firm, such as taking an ownership stake or providing loans.
The administration also wants to expand oversight of a broad category of unregulated investment firms including hedge funds, private-equity funds and venture capital funds, by requiring larger companies to register with the Securities and Exchange Commission. Firms also would have to provide financial information to help determine whether they are large enough to warrant additional regulation.