House Committee Moves to Pick Up First Parts of Systemic Risk Reform

Resolution authority and capital requirements, aspects of the systemic risk debate, are on tap this week in the House Financial Services Committee. From NYT:

Congress and the Obama administration are about to take up one of the most fundamental issues stemming from the near collapse of the financial system last year — how to deal with institutions that are so big that the government has no choice but to rescue them when they get in trouble.

A senior administration official said on Sunday that after extensive consultations with Treasury Department officials, Representative Barney Frank, the chairman of the House Financial Services Committee, would introduce legislation as early as this week. The measure would make it easier for the government to seize control of troubled financial institutions, throw out management, wipe out the shareholders and change the terms of existing loans held by the institution.

The official said the Treasury secretary, Timothy F. Geithner, was planning to endorse the changes in testimony before the House Financial Services Committee on Thursday.

The White House plan as outlined so far would already make it much more costly to be a large financial company whose failure would put the financial system and the economy at risk. It would force such institutions to hold more money in reserve and make it harder for them to borrow too heavily against their assets.

Setting up the equivalent of living wills for corporations, that plan would require that they come up with their own procedure to be disentangled in the event of a crisis, a plan that administration officials say ought to be made public in advance.

See my full analysis and commentary on these issues in our recent review of the Obama plan for reforming financial services. Two of the more relevant recommendations are:

Capital Requirements: Don’t depend on capital requirements or reserve ratios to guide financial institution risk assessment, but rather make sure those firms understand the painful consequences of failure, and be prepared to let them fail.

Bankruptcy vs. Resolution: Use bankruptcy laws, well developed over the past several decades, to wind down insolvent financial institutions instead of an unfunded resolution authority. If necessary, Treasury could be granted authority to step into non-banks and force them into “chapter 14” bankruptcy if their insolvency was imminent, similar to authority over banking institutions.

See all recommendations here.