Geithner Outlines Part 1 Of Sweeping Financial Regulatory Reform: Systemic Risk

Treasury Secretary Tim Geithner testified before the House Financial Services Committee today discussing sweeping financial regulatory reform. The current crisis exposed critical gaps and weaknesses in the financial regulatory system. Geithner said to fix these problems we can't just have "modest repairs at the margin" but we need "new rules of the game."

Geithner outlined four broad components of comprehensive regulatory reform: 1. Addressing Systemic Risk, 2. Protecting Consumers and Investors, 3. Eliminating Gaps in Our Regulatory Structure, 4. Fostering International Coordination. Today, Geithner focused on one of these broad components - Systemic Risk.

To addresses systemic risk Geithner is proposing:

• A single independent regulator with responsibility over systemically important firms and critical payment and settlement systems. Geithner said we must create higher standards for all systemically important financial firms.
  
• Higher standards on capital management and systemically important firms. Capital requirements for these firms must be more conservative than for other institutions. Supervisors will also need to impose liquidity, counterparty, and credit risk management requirements that are more stringent than for other financial firms.
  
• Geithner is proposing that all hedge funds above a certain size to register. Geithner said, "in the wake of the Madoff episode it is clear that, in order to protect investors, we must close gaps and weaknesses in regulation of investment advisors and the funds they manage."
  
• Geithner also want to regulate the markets for credit default swaps and over-the-counter derivatives for the first time. Geithner said, "The current financial crisis has been amplified by excessive risk-taking by certain insurance companies and poor counterparty credit risk management by many banks trading Credit Default Swaps (CDS) on asset-backed securities. These complex instruments were poorly understood by counterparties, and the implication that they could threaten the entire financial system or bring down a company of the size and scope of AIG (NYSE: AIG) was not identified by regulators, in part because the CDS markets lacked transparency."
  
• Geithner also wants new requirements for money market funds to reduce the risk of rapid withdrawals. Geithner noted, "In the wake of Lehman Brothers' bankruptcy, we learned that even one of the most stable and least risky investment vehicles - money market mutual funds - was not safe from the failure of a systemically important institution"
  
• Finally, Geithner said we must create a resolution regime that provides authority to avoid the disorderly liquidation of any nonbank financial firm whose failure would have serious adverse effects on the financial system or the U.S. economy.

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