By David Cho, Brady Dennis and Neil Irwin
Washington Post Staff Writer
Tuesday, October 27, 2009
House Democrats and the Obama administration are preparing to introduce major legislation aimed at eliminating the devil's choice the government faced last fall, when officials felt forced to decide between spending billions of dollars to rescue some of the nation's most powerful financial firms or letting their failures sink the economy.
The lawmakers and Treasury Department officials labored over the weekend to finish drafting legislation that would empower the government to seize troubled firms other than banks that are deemed "too big to fail." The legislation would set up the Federal Reserve to oversee the largest financial firms, and eliminate the agency that regulates thrifts. The officials said the measure could be unveiled as soon as Tuesday.
The proposal comes as debate intensifies over how far the government should go in restructuring the financial system, and it follows House action last week toward creating a consumer protection agency to oversee lending practices. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, is shepherding the effort, in close coordination with Treasury.
Officials at Treasury and the Fed have pushed for "resolution authority" over non-bank financial firms for months, viewing it as one of the most important tools for dealing with future crises.
The intent of the new authority would be to give a government agency the power to take over a failing firm and dissolve it outside of the bankruptcy process, injecting money if necessary to make the unwinding orderly. Shareholders and creditors of the failing company would incur losses, and the financial industry would foot the bill for any bailout.
Under the current draft of the legislation, financial firms would not be assessed an upfront fee that would be used to cover the government's cost of managing major failures, a Democratic official said. Instead, the bill calls for imposing such fees after a collapse in order to recoup the government's expense, the official said.
"We are pursuing a policy of polluter pays," said the official, who commented on the condition of anonymity because the details had not yet been announced. "There would be no taxpayer money put into this."
Responsibility for monitoring risks in the financial system would be shared between the Fed and a council of bank regulators.
The central bank would be responsible for directly supervising the largest financial companies -- including big banks, giant insurers, and possibly even private equity firms and hedge funds -- and would force them to hold more capital in their reserves. Frank's bill, however, gives more power to the council than the administration originally envisioned, including the ability to determine which firms are put under the Fed's umbrella of oversight.
The bill proposes eliminating the Office of Thrift Supervision, which has been widely blamed for missing problems at some of the nation's biggest financial firms, including Washington Mutual and American International Group. Thrifts would continue to exist and would be monitored by the Office of the Comptroller of the Currency, which would be renamed the National Bank Supervisor.Prominent economists
A handful of prominent economists, including former Fed chairmen Alan Greenspan and Paul A. Volcker, who is President Obama's top outside economic adviser, say the administration's plan would not be enough to prevent another crisis. Financiers will find loopholes in any new regulations that are set up by the government, these economists warn. Greenspan and Volcker, in particular, have advocated for splitting up big banks.
Officials at Treasury and the Fed have been skeptical that such a break-up would work in practice. Daniel K. Tarullo, a Fed governor, said last week that dividing up the biggest banks would be fraught with "conceptual and practical challenges," and is "more a provocative idea than a proposal," though he added that having the idea in circulation can help focus the debate toward containing the risks created by enormous banks.
Fed Chairman Ben S. Bernanke also weighed in on Friday, saying he preferred "a more subtle approach without losing the economic benefit of multifunction, international firms."
Meg Reilly, a Treasury spokeswoman, declined to comment.Concerns remain
Republicans on the House Financial Services Committee have remained skeptical of granting the government power to wind down or bail out large, non-bank financial institutions. In July, they proposed creating a new chapter in the bankruptcy code to deal with such troubled firms, saying it would make for a smoother, fairer process.
"We think that's a better way to deal with failed non-banks," a Republican staff member, who was not authorized to speak on the record, said Monday. "That way, politics is not part of the equation."
Concerns have also deepened in Congress, among Republicans and some Democrats, that the program could amount to a permanent bailout fund and reduce private market discipline by being too generous to creditors of failed firms.
Despite such differences, the problem is clear to all sides: Banks got so big that federal officials could not let them fail without risking catastrophic consequences for the economy. During the crisis, the government arranged mergers that pushed troubled banks into the arms of more stable firms. Big firms got even bigger. Senior officials now worry that these financial behemoths could return to the reckless behavior that led to the crisis, reasoning that federal officials will clean up any mess.
Frank has made clear that he expects the new proposals will be contentious. Last week, after his committee had voted to create the new consumer financial protection agency, he was asked whether the most difficult and divisive part of regulatory overhaul was behind him.
Frank didn't hesitate. "I think the resolution authority is probably the hardest to do," he said.