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Financial Services Committee and Treasury Department Release Draft Legislation to Address Systemic Risk, “Too Big to Fail” Institutions

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Washington, DC, October 27, 2009 | comments

Today, the House Financial Services Committee and the Treasury Department released draft legislation to address the issue of systemic risk and “too big to fail” financial institutions. The draft bill will:

  • Create a mechanism for monitoring and reducing the threats that systemically risky firms pose to the financial system.
  • Establish a process for winding down large, financially-troubled non-bank financial institutions in a way that protects American taxpayers and minimizes the impact on the financial system.
  • Overhaul and update our financial regulatory system.

A summary of the draft legislation can be viewed below; the full text can be viewed here.

Summary of the Financial Stability Improvement Act

The Financial Services Committee and the Obama Administration are committed to ensuring that the taxpayers are never again called upon to take responsibility for Wall Street’s business decisions.  The bill creates a strong, inter-agency council to monitor and oversee stability of the financial system and address threats to that stability.  The bill provides strengthened supervision for large, interconnected financial firms to prevent failure.  A new resolution regime will ensure that firms that fail despite these measures will do so in a way that minimizes impacts on taxpayers, the health of the financial system and the overall economy.

Specifically, the draft legislation:

Creates the Financial Services Oversight Council to monitor systemic risks.

  • The Council will identify financial companies and financial activities that pose a threat to financial stability, and will subject those companies and activities to heightened prudential oversight, standards and regulation. 
  • The Council will also subject systemically important financial market utilities and payment, clearing and settlement activities to heightened oversight, standards and regulation. 

 
Harmonizes and consolidates holding company regulation so there is “no place to hide,” ensures communication and coordination among regulators and maintains clear lines of authority

  • Removes the Gramm-Leach-Bliley Act’s restraints on the Fed’s authority over companies subject to consolidated regulation and provides specific authority to the Fed and other federal financial agencies to regulate for financial stability purposes and quickly address potential problems.  
  • Puts safeguards on current ILC and other non-bank bank institutions and closes the ILC and other non-bank bank exemptions going forward; current non-bank banks, industrial loan companies, and similar companies that engage in commercial activities but are not currently subject to bank holding company regulation will not have to divest, but will have to restructure, creating a bank holding company to hold all financial activities, and will face limits on transactions between the bank holding company and any commercial affiliates.  Going forward, no additional commercial companies will be allowed to own banks, ILCs or any other specialty bank charters. 
  • Preserves the thrift charter for those thrifts dedicated to mortgage lending, but subjects thrift holding companies to supervision by the Fed to eliminate opportunities for regulatory arbitrage. 

Subjects firms or activities that pose significant risks to the system to heightened, comprehensive scrutiny by Federal regulators.

  • Regulators’ inability to see developments outside their narrow “silos” allowed the current crisis to grow unchecked.  The bill’s information gathering and sharing requirements for the Council and all of the financial regulators (including SEC and CFTC) will ensure constant communication and the ability to look across markets for potential risks.    
  • Federal regulators will impose heightened standards through a variety of options tailored to the specific threat posed – there is no “one size fits all” approach
  • The Fed will have back-up authority to step in if regulators do not act quickly to address developing problems identified by the Council. 

Provides for the orderly wind-down of failing firms and ends “too big to fail” to ensure that industry and shareholders absorb the risks and costs of failure, not taxpayers.

  • Large, highly complex financial companies that fail will do so in an orderly and controlled manner, ensuring that shareholders and unsecured creditors bear the losses, not taxpayers, and the stability of the overall financial system is protected. 
  • The FDIC will be able to unwind a failing firm so that existing contracts can be dealt with, creditors’ claims can be addressed, and parties required to bear losses do so.  Unlike traditional bankruptcy, which does not account for complex interrelationships of such large firms and may endanger financial stability, this more flexible process will help prevent contagion and disruption to the entire system and the overall economy. 
  • Costs to resolve a failing firm will be repaid first from the assets of the failed firm at the expense of shareholders and creditors, and to the extent of any shortfall, from assessments on all large financial firms.  In this instance we follow the “polluter pays” model where the financial industry has to pay for their mistakes—not taxpayers.  
  • Resolution Fund is structured to spread the cost over a broad range of financial companies with assets of $10 billion or more, and provides for a flexible repayment period to avoid potential procyclical effect of such assessments.

Provides new accountability for the Fed when it addresses short-term credit market disruptions in emergency situations.

Requires approval by the Treasury Secretary for the Fed to provide temporary liquidity assistance using section 13(3) of the Federal Reserve Act, and confines that assistance to generally available facilities.
 
Credit Risk Retention

  • Directs the federal banking regulators and the Securities and Exchange Commission to jointly write rules to require creditors to retain 10 percent or more, of the credit risk associated with any loans that are transferred or sold including for the purpose of securitization.  Regulators can adjust the level of risk retention above or below 10 percent, but not lower than 5 percent.  In the case of the securitization of assets that are not originated by creditors, the regulators will require the securitizer to retain the credit risk. 


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