Treasury Secretary Timothy Geithner finally opened the can of worms last week, proposing a far-reaching plan to reform the financial system. He said the system had failed “in fundamental ways” and would require comprehensive overhaul. “Not modest repairs at the margin,” he told Congress, “but new rules of the game.” Geithner’s audience, the House Financial Services Committee, for once seemed to be satisfied with his presentation, which included regulating hedge funds and giving the government the power to seize and dismantle companies deemed a threat to the economy.
The key measures of Geithner’s proposal include:
- Creating a new “sytemic risk regulator” that would have the authority to scrutinize and second-guess the operations of bank holding companies like JPMorgan Chase, insurance conglomerate American International Group and other institutions that are too big to fail.
- Establishing a mechanism to seize and dismantle large institutions whose collapse or bankruptcy might threaten the nation’s financial stability.
- Passing tougher requirements for the amount of money and assets that financial institutions need to have on hand so they can withstand economic troubles.
- Requiring hedge funds, private-equity firms and other private investment funds to register with the Securities and Exchange Commission and tell it about their risk-management practices.
- Setting up a new, comprehensive framework of regulation of derivatives, including a central clearinghouse for trades in that market.
- Developing stronger requirements for money market funds so increased withdrawals won’t threaten the broader financial system.
Many of these proposals should generate a big welcoming, addressing dangers that clearly could have been addressed with simple regulatory reform. In the months ahead, Geithner said he will unveil more detailed proposals.
Nonetheless, a New York Times editorial posted today talk about the big underlying issues that Congress and the administration need to keep in mind. For instance:
- Is too big too fail actually exist? Such firms, like A.I.G., have proved dangerous mainly because of their involvement in a web of often conflicting financial practice and products. Geithner has called for a single regulator to police the most powerful institutions and presumably intervene in order to seize and restructure if failure seemed imminent. But, at what point should a firm ever even come close to become “too big” — i.e. too diverse, too interconnected — too fail?
- What are we trying to fix, anyway? Does anyone understand, with specificity, what brought on the financial meltdown? Can anyone actually sort out how much of the crisis is due to regulatory failure, how much to recklessness and greed, or how much to fraud and manipulation? Without the answers, the reform effort will be at best, hit or miss.
- Who is to carry out the reforms? For the last 30 years, there has been a serious political movement against regulation and for deregulation. In the last 10 years alone, opponents of financial regulation (e.g. Alan Greenspan) have been especially succesful in dismantling our financial regulatory scheme– letting the market forces run free. As a result, the very agencies that were formed to protect our interests struck out — big time. So if there is going to actually be meaningful regulatory reform, the rules will only be the first step.