Treasury Secretary Timothy Geithner unveiled sweeping new “rules of the game” Thursday, seeking dramatically expanded federal powers to regulate a broad swath of the financial industry including hedge funds, derivatives trading and money-market mutual funds.
The blueprint seeks to achieve two objectives as laid out by President Barack Obama to crack down on abusive practices on Wall Street while at the same time allowing financial markets to thrive.
The pendulum is moving back towards greater regulation of Wall Street because of the financial crisis that built slowly after the collapse of the sub-prime mortgage market in early 2007 but exploded into the worst financial crisis since the Great Depression. Seemingly overnight, investment banks like Merrill Lynch, Bear Stearns and Lehman Brothers collapsed or were gobbled up by competitors.
“What we need is better, smarter, tougher regulation, because we’ve seen the costs of these weaknesses and gaps are catastrophic to the system as a whole.” Geithner told the House Financial Services Committee.
‘In the wake of the Madoff episode it is clear that, in order to protect investors, we must close gaps and weaknesses in regulation of investment advisors and the funds they manage.’
Treasury Secretary Timothy Geithner
Geithner used the occasion to build further support for proposals that have already been made public, including his bid to create a systemic regulator that would be able to delve into every corner of the financial markets, and new government powers to oversee liquidation of a firm whose disorderly failure might damage financial markets.
Firms that are deemed to be systemically important large institutions must be able to give the government a comprehensive report on their aggregate counterparty risks exposures “within a matter of hours.”
Financial-sector industry experts said the Geithner proposals appear to be bold, but many stressed that the devil would be in the details, much of which were left out of the outline given to Congress.
In an illustration of this point, lobbyists said it would be crucial to learn the criteria for how to determine what would be a systemically important firm.
Although the proposals would give the government significantly broader regulatory power, Geithner took pains, at least for a day, to steer clear of a widely anticipated Washington battle over which agencies should be empowered to tackle his agenda.
In his remarks before lawmakers, he said he was trying to concentrate on the substance of the reform agenda, “rather than the complex and sensitive questions of who should be responsible for what.”
“We must not let turf wars or concerns about the shape of organizational charts prevent us from establishing a substantive system of regulation that meets the needs of the American people,” Geithner said.
The Treasury’s plan seeks to extend federal regulation — for the first time — to include all trading in the massive market for financial derivatives.
Geithner asked Congress to require all “private investment funds with assets under management over a certain threshold” to register with the Securities and Exchange Commission and disclose certain information so government officials can determine whether their size or complexity puts the broader economy at risk.
Under the proposals, hedge-fund advisers would also have to register with the SEC, another first that already has stirred strenuous objections by the industry.
“In the wake of the Madoff episode it is clear that, in order to protect investors, we must close gaps and weaknesses in regulation of investment advisors and the funds they manage,” Geithner said.
Hedge funds appeared to be willing to bow to an inevitable move from Washington to place new regulations around their activities.
James Chanos, the chairman of the Coalition of Private Investment Companies, didn’t object to the regulation and instead focused his attention on smaller details. He said hedge funds wanted the SEC to “focus on the market-wide issues that are relevant” without “substituting government mandates for current investor scrutiny.”
The banking industry tried to sound supportive of Geithner’s testimony, but raised a few red flags at the same time.
“There is much to like in the Treasury’s proposals,” said Edward Yingling, the president of the American Banking Association.
But he quickly added that he was worried about funding of any new power to wind-down a big firm.
The banking industry funds the FDIC’s deposit insurance fund, with the taxpayer on the hook if the fund proves insufficient.
“It would be completely unfair to pull resources from the banking industry to resolve non-banks,” Yingling said.
The SEC should also develop stronger rules for money market mutual funds to reduce the risk of runs on the funds.
Regulators also would be able to issue standards for executive compensation practices across all financial firms.
Much of Geithner’s remarks focused on hope for tighter international control, a hot-button issue on the eve of next week’s G20 summit of world leaders that are expected to butt heads over ways to fix the global financial meltdown.
He talked about the importance of global rules so that no country becomes a haven for riskier activities.
He said President Obama will push the G20 leaders to join “a race to the top rather than a race to the bottom.”
But already countries like the United Kingdom are moving to protect their financial markets from international oversight.
Geithner said that “at the center” of his proposal is the knowledge that the U.S. cannot move alone.
“We will launch a new initiative,” he said, “to address prudential supervision, tax havens, and money laundering issues in weakly regulated jurisdictions.”