Treasury Secretary Presents Regulatory Restructuring Plan to Senate Committee

By W. Bernard Mason

A day after the Administration announced its blueprint for regulatory reform, Treasury Secretary Geithner appeared before the Senate Banking, Housing and Urban Affairs Committee to answer questions and defend the proposal. In his opening statement, Secretary Geithner emphasized that input had been sought from all sources - Congress, regulators, consumer advocates, business leaders, academics and the broader public. He stated that the proposal does not address every problem and does not propose reforms that, while desirable, would not move toward achieving core objectives. He presented his support for the plan to establish a systemic regulatory authority, a separate consumer protection entity, enhanced capital buffers and transparency, and broader failure resolution authority.

The opening statements of both Committee Chairman Christopher Dodd (D - CT) and Ranking Member Richard Shelby (R - AL) revealed strong skepticism toward the Administration's proposal to grant broader supervisory authority, as systemic risk regulator, to the Federal Reserve Board. This sentiment would be echoed by most of the Committee members during subsequent questioning.

Senator Dodd fully endorsed the concept of consolidating consumer protection authority within a single regulator and somewhat angrily cited morning news headlines suggesting the banking industry was opposed to such a concept, stating that the very ones who created the mess are the ones saying consumers should not be protected. "To attack the very clients and customers you depend upon each day is not the place to begin", he admonished. He stated his view that stronger consumer protection would have stopped this crisis before it started.

Senator Shelby hinted that he was not as confident as some that consensus has been reached on what the guiding principles should be, what the concept of systemic risk was or whether it can even be regulated. He repeated his previously publicized concerns regarding the inherent conflict of interest presented by the Federal Reserve's structure and its supervision of banks. He said events have shown that the Federal Reserve is not structured to be an effective bank regulator. He also pointed out his reservations regarding the Federal Reserve's ability to assume further responsibility while carrying out its primary mission of monetary policy oversight. Mr. Geithner agreed that the Federal Reserve's structure is complicated, and the Administration has requested the Fed to take a close look at its structure and come forward with proposals to modify its governance structure by October 31.

Senator Charles Schumer (D - NY), while also criticizing the Federal Reserve's performance in the consumer protection area, was one of the few Committee members to suggest that giving the Federal Reserve systemic risk authority was probably the best answer. Senator Schumer believes vesting such authority with a regulatory council would be "a formula for disaster - everyone would pass the buck". Senator Schumer faulted the Administration's plan because it does little to reduce the actual number of regulators. With the Federal Reserve gaining additional authority, he wondered why it shouldn't give up supervision of state banks.

Secretary Geithner reminded the Committee that the Administration was not seeking perfection in its proposal; the focus is on those problems that were central causes of the crisis. The Administration does not want to spend time and effort on changes that do not accomplish this.

Senator Robert Bennett (R - UT) focused on a particular provision of the proposal that would eliminate the existence of industrial loan companies (ILC) by treating them as holding companies subject to Federal Reserve supervision and oversight. He was perplexed that ILCs would be singled out for extinction when not one such entity had been a contributor to the current crisis, answering his own question by observing that the Federal Reserve had been attempting to gain regulatory control of these companies for years and found this mechanism to be a convenient means to solve the problem. Secretary Geithner admitted that ILCs were not implicated in the current crisis, but noted they did operate outside the control of formal supervisory oversight and the intent of the restructuring plan was to level the playing field for all entities offering similar financial services. He said he was open to working with Congress on alternatives to this issue.

Senator David Vitter (R - LA) obtained Secretary Geithner's agreement that Fannie Mae and Freddie Mac were significant contributors to the current financial crisis. Senator Vitter then inquired as to why, if the proposal is to address core problems, we "are punting" on these issues. Mr. Geithner stated that Congress had legislated changes last year addressing the GSE oversight regime, and the Administration did not want to rush through further measures at this stage. He stated that the challenge with Fannie Mae and Freddie Mac, and the government more generally, is an effective exit strategy. He said we need to re-think the role of government in the future - "We did not get that right".

Senator Mark Warner (D - VA) echoed previous concerns regarding expansion of Federal Reserve authority and worried that extending the requirement for Treasury approval of Fed actions in "systemic risk" situations could serve to politicize the process. He believes systemic risk supervision should be given to a council whose membership would include the Federal Reserve, Treasury, the prudential regulators, and an independent chair, with a staff solely focused on systemic risk evaluation and independent power to act. He also questioned how the proposed expanded resolution authority would be funded. Secretary Geithner indicated that there would be no up-front funding for potential systemic risk failure resolutions - should a failure occur, any government losses would be recouped over time through assessments against remaining systemically important entities.

Senator Jon Tester (D - MT) inquired as to why the Administration had not proposed combining the Securities and Exchange Commission with the Commodities Futures Trading Commission. While Secretary Geithner argued that the prevailing view was this was unnecessary, he indicated a willingness to work with Congress should such a combination prove effective.

Senator Bob Corker (R - TN) stated his view that a lot of the "heavy lifting" such as dealing with the GSEs and merging the SEC with the CFTC, had not been addressed. He also wondered if it would not be advisable to have the President sign a statement assuring that none of the Administration officials involved in developing the reform plan would subsequently be appointed as Federal Reserve Board Chairman. Secretary Geithner stated he did not believe that to be appropriate; neither did he think such a statement was necessary.

Senator Mike Crapo (R - ID) questioned the benefits of separating consumer protection from prudential supervision. He cited previous testimony from Comptroller of the Currency John Dugan arguing against such a separation. While indicating his support for Comptroller Dugan, Mr. Geithner stated that history had shown the present structure has not worked. During his questioning, Senator Herb Kohl (D - WI) cited testimony from FDIC Chair Sheila Bair stating that separating consumer protection from safety and soundness will weaken each. Secretary Geithner again argued that the present system has not worked.
Other Committee members expressed doubt or outright opposition to the proposal to grant systemic authority to the Federal Reserve. Many members accused the Fed of failing to use its existing powers to avert, or lessen the impact of, the current crisis.

Committee Chairman Dodd predicted that legislation addressing this proposal would be enacted by yearend.