Tighter Regulation of Non-Banks Urged

As the House considers a bill that would impose hefty taxes on bonuses paid to employees by firms that have received significant amounts of government aid, the administration might soon be requesting “resolution authority” to step in and effectively seize troubled companies, according to recent statements by President Barack Obama. “This is part of the broader package of financial regulatory steps that we’re going to be taking that ensures that, going forward in the future, we’re not going to find ourselves in these kinds of terrible positions again,” he said, according to an Associated Press report. The AP‘s sources have said a forthcoming proposal from the administration would allow the Treasury Department secretary to seize control of a major financial institution — after gaining the blessing of Federal Reserve officials — and run that company in what would basically work as conservatorship. Such a system, if it had been in place before the American International Group Inc. (AIG) bonus distribution, would have allowed the administration to block the company’s bonus flop. If enacted, the plan will allow the administration to proactively prevent the payment of bonuses at significant institutions, rather than reacting after-the-fact as Congress plans to do with some version of the House’s 90 percent tax on bonuses. Fed board of governors member Daniel Tarullo, in testimony delivered Thursday before a Senate committee on “modernizing” bank regulation, said merely supervising banks is not enough. He called for “statutory coverage” of any systemically significant firms, not just those affiliated with an insured bank. “The current financial crisis has highlighted a fact that had become more and more apparent in recent years–that risks to the financial system can arise not only in the banking sector, but also from the activities of financial firms that traditionally have not been subject to the type of consolidated supervision applied to bank holding companies,” he said. Tarullo urged that “especially close supervisory oversight” of the risk-taking behaviors, risk management and capital conditions traditionally applied to bank holding companies also be applicable to all institutions. “Application of a similar regime to systemically important financial institutions that are not bank holding companies would help promote the safety and soundness of these firms and the stability of the financial system generally,” he said, although he acknowledged the need for clear guidelines on just which firms would be subject under the new regime, as opposed to the broad and debatable “too big to fail” standard. “One issue that has received much attention recently is the possible benefit of establishing a systemic risk authority that would be charged with monitoring, assessing and, if necessary, curtailing systemic risks across the entire U.S. financial system,” Tarullo said. Such an authority would need to have a “sophisticated” and thorough approach to systemic risk, clear and detailed expectations and responsibilities and proper supervision. Federal Deposit Insurance Corp. chairman Sheila Bair, before the same Senate committee, also called for some sort of “legal mechanism for the orderly resolution” of significant financial institutions similar to that in place at FDIC-insured banks. She went so far as to urge not just the elimination of the “too big to fail” standard in supervision and tighter regulation, but an end to the complexity and over-leveraging of banks and institutions that makes them “too big to fail” in the first place. “In the face of the current crisis, regulatory gaps argue for some kind of comprehensive regulation or oversight of all systemically important financial firms,” she said in her testimony. “But, the failure to utilize existing authorities by regulators casts doubt on whether simply entrusting power in a single systemic risk regulator will sufficiently address the underlying causes of our past supervisory failures. We need to recognize that simply creating a new systemic risk regulator is a not a panacea.” Bair called on Congress to consider limitations on the size and complexity of systemically significant institutions whose failures would cause far-reaching damage. She also urged institutions to recognize limits to diversified risk through securitization, structured finance and derivatives. “If large complex organizations concentrate risk and do not provide market efficiencies, it may be better to address systemic risk by creating incentives to encourage a financial industry structure that is characterized by smaller and therefore less systemically important financial firms, for instance, by imposing increasing financial obligations that mirror the heightened risk posed by large entities,” Bair said. Overall, she encouraged a “thoughtful, deliberative approach” to establishing tighter regulations on non-banks and urged “prudential supervision” of significant non-bank institutions — including hedge funds and investment banks, insurance companies and bank and thrift holding companies. “[H]aving a mechanism for the orderly resolution of institutions that pose a systemic risk to the financial system is critical,” Bair said. “Creating a resolution regime that could apply to any financial institution that becomes a source of systemic risk should be an urgent priority.” Kelly Curran contributed to this report. Write to Diana Golobay at [email protected] and to Kelly Curran at [email protected]. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.