Obama to Limit Fed Lending Power, Grant Systemic Role
The Obama administration plans to restrict the Federal Reserve’s emergency-lending powers while endowing it with new authority for systemic risk, ushering in what may become the Fed’s biggest overhaul in decades.
President Barack Obama’s proposal on financial regulation, to be released in Washington today, would force the central bank to get written approval from the Treasury secretary before using the authority, according to a copy of the document obtained by Bloomberg News. Obama also calls for a study of the Fed’s governance structure, including how it regulates financial firms.
The move is part of a proposal that would alter almost every facet of federal rules for the industry, aiming to prevent the regulatory lapses and build-up of risks that led to the worst crisis since the Great Depression. Much of the plan will require approval in Congress, where jurisdictional battles and ideological clashes may delay and alter the legislation. Obama aims to sign a bill by the end of the year.
“We have to have somebody who is responsible for seeing the risks of the system as a whole and not just individual institutions,” Obama said yesterday in an interview with Bloomberg News, referring to making the Fed the systemic risk regulator. “The Fed is best positioned to do that.”
New Agency
A new agency would oversee consumer financial products, such as mortgages and credit cards. The proposal, much of which has been reported earlier, encompasses areas ranging from derivatives to executive pay to the mortgage-backed securities that helped fuel the housing boom and touch off the credit crisis. It also requests federal oversight for the first time for hedge and private equity funds.
The Treasury and outside experts “should have substantial input into the review and the resulting report” on the Fed’s governance study, according to the paper. The Treasury can propose changes to the central bank’s structure “to improve its accountability and its capacity to achieve its statutory responsibilities.”
Obama said changes are needed to restore confidence in U.S. markets. “We now need some sensible rules of the road so that people aren’t taking exorbitant risks,” he said.
The overhaul comes on the heels of the credit crisis, the collapse of major Wall Street firms like Bear Stearns Cos. and the government’s $700 billion bailout for the banking, auto and insurance industries.
Extra Capital
“While this crisis has had many causes, it is clear now that the government could have done more to prevent many of these problems from growing out of control and threatening the stability of the financial system,” Obama’s administration says in the document.
Investment banks “operated with insufficient government oversight” while hedge funds exist “completely outside of the supervisory framework,” according to the paper payday advance loan.
The administration is seeking to require firms that pose the biggest risk to the financial system to hold extra capital. It proposes those levels should be determined by Dec. 31. It asks for a committee, led by the Treasury, to do a “fundamental reassessment” of how banks are supervised by Oct. 1.
The administration downplayed reining in the Fed’s emergency powers, and said the central bank sought and received the Treasury secretary’s approval for lending during the crisis.
The administration called for a national insurance office within the Treasury to gather information about the industry and try to identify gaps in regulation that “could contribute to a future crisis,” according to the plan.
Insurance Industry
The office will also make recommendations to the Fed on whether it should regulate individual insurance companies as systemically important, subjecting them to capital and leverage requirements.
The proposal follows multiple government bailouts of American International Group Inc., once the world’s largest insurer before losses on derivative contracts put the company on the brink of collapse. It stops short of recommending federal regulation of insurance companies, which are overseen by states.
Additional insurance regulation would be considered if it would “further reduce systemic risk,” according to the paper.
The administration plans to offer recommendations on housing-finance companies Fannie Mae and Freddie Mac, which were effectively seized by the government last year, by the time the 2011 federal budget is released.
‘Continued Stability’
“We need to maintain the continued stability and strength” of the companies “during these difficult financial times,” the paper says.
The Obama proposal calls on the Securities and Exchange Commission to make brokerage firms fiduciaries to their clients. Such a standard, which already applies to money managers, would require brokers to put their customers’ interests above the firm’s in securities transactions.
Obama would tie compensation for market participants who securitize loans to the performance of the assets over time, according to the document. The pay for brokers, underwriters and others who package mortgages into bonds “should be linked to the longer-term performance of the securitized assets, rather than only to the production, creation or inception of those products,” the paper says.