Shortly after children rolled Easter eggs on the White House South Lawn, President
Obama pressed Congress to send him comprehensive financial-industry regulatory
reform by year-end. Can they do it? In short, we doubt it. Despite the spring bloom
that surrounds the Washington power venues, December is a remarkably short-turn
around date for comprehensive, controversial legislation that has yet even to be
formally introduced and on which critical points of difference remain.
Of course, one plank is down: the Treasury approach to systemic-risk resolution (see
FSM Report SYSTEMIC4). That plan puts the FDIC in charge of a resolution process
for the parent companies of regulated financial institutions, including insurers. As
detailed in our review of the legislation and a policy analysis of it (see Client Report
SYSTEMIC5) the Treasury plan would give the FDIC virtually unlimited authority
to support a troubled systemic-risk firm – living or dead – and it would force none of
the conditions Congress has required as it has become increasingly unhappy with the
TARP (see Client Reports in the COMPENSATION and RESCUE series). This can’t
last – we expect Congress tightly to condition FDIC discretion. We also expect
Congress to take a dim view of the payment mechanism Treasury has proposed for
systemic risk resolutions – in which systemic-risk firms would somehow reimburse
taxpayers for the potentially huge costs of any rescue of their peers.
Not only will Congress question the answers Treasury has already provided, but it
will also not move on the resolution regime until Treasury comes up with a critical
missing piece: the answer to who’s a systemic-risk firm and how they are regulated.
Secretary Geithner was clearly aware that providing the resolution legislation before
the regulatory piece is a bit like announcing funeral plans before the doctor even
does a checkup. At a March 26 hearing (see Client Report SYSTEMIC3), he told
House FinServ that much in the resolution regime would need to be revised once the
regulatory framework is finalized As a result, even the bill Treasury has proposed is
So far, the leading contender for systemic-risk regulator is the Federal Reserve. Mr.
Geithner appears to favor this even though several at the Fed – most recently the
president of the Federal Reserve Bank of Boston – view the prospect with qualms.
The reason? Congress will surely not give the Fed new powers without taking some
Indeed, the die there may already be cast. Provisions in the non-binding Senate
budget resolution (see FSM Report FEDERALRESERVE2) take a hard whack at the
Fed, pushing not only for new GAO audits, but also for extensive disclosures on all
the FRB’s recent rescue activities. For good measure, the legislation includes a
Sanders (I-VT) amendment dictating disclosures also from anyone using the various
In short, none of this is easy and all of it will take time. And, by then, the industry
may already have begun to redefine itself. Another critical question in the regulatory
rewrite is not just which firms trigger systemic-risk regulation, but also what those
firms will look like. Congress is pushing for a realignment of the industry into more
coherent commercial versus investment banking pieces – a point Mr. Obama’s
adviser, Paul Volcker, implicitly endorsed in the G-30 report (see Client Report
REFORM3). We doubt Congress can pull the industry apart in the course of the
regulatory rewrite, but its need to do so will diminish as market forces in the
intervening months force both rationalization and, in some cases, resolution. The
new stress tests (see Client Report STRESS2) will start this realignment well before
Congress gets down to work and, even then, strong firms will take the steps they
need to protect themselves as the policy debate advances. One thing we know for
sure – Congress isn’t good at taking away that which is in place when it finally
passes a law. .