Fed Should Survey Overall Financial System: Volcker
The House Financial Services Committee met Thursday to hear expert testimony on systemic risk in the financial system and the potential role of resolution authority in unwinding troubled firms. A key witness at the meeting, former chairman of the Board of Governors of the Federal Reserve System Paul Volcker, urged the registration of hedge funds and private equity funds and suggested the Federal Reserve should oversee the overall financial system. Committee chairman Barney Frank (D-Mass.) reiterated a "universal dislike" of too-big-to-fail institutions, noting there is no apparent single solution and any legislation adopted by the House would implement a series of steps to prevent these systemic presences in the market. Additionally, the legislation should adopt a resolution authority or "death panel" that would "put an institution to death" when it becomes clear it can no longer function, Frank added in his opening remarks. Rep. Spencer Bachus (R-Ala.), on the other hand, maintained his opposition of much of the Administration's proposed regulatory reforms. He brought the issue of firms considered "too small to save," indicating the existence of uneven treatment of financial firms. Bachus called to considered resolution authority a "permanent TARP" (or Troubled Asset Relief Program). He noted Treasury Department secretary Tim Geithner at the hearing Wednesday would not rule out the possibility of future bailouts of systemic firms. Bachus noted a contrasting support by House Republicans supports bankruptcy proceedins for failed non-bank institutions. He said firms "can and should fail as their bad decisions render them insolvent." Volcker instead supported placing insolvent non-bank firms into the proposed resolution authority. He indicated he is "more than somewhat resistant" to the Administration's proposal. A majority of systemic institutions are commercial banks, he noted, adding that a safety net already exists for those banks, which are subject to deposit insurance and other means of support. Banking and insurance companies are most systemic, he said, and an extension of regulation beyond these firms would increase moral hazard issues. But private equity firms and hedge funds are not outside the realm of supervision and should register and report to supervising agencies, Volcker said. Private equity, hedge funds, credit default swaps (CDs) and collateralized debt obligations (CDOs) are different businesses from commercial banking, however, he said. The economy needs strong capital markets; it's a different business -- an impersonal, useful trading business, Volcker added. "As a matter of broad policy, an assumption that those non-bank institutions would come into the framework of the Federal safety net should be discouraged," Volcker said in prepared remarks. "The credibility of that approach will need to be supported by legislation." Volcker added: "A designated regulatory agency will need to be provided authority to set rules for capital, leverage, and liquidity for those few institutions that may be large enough to pose systemic risk." But any legislation eventually passed should prohibit banks and their bank holding companies (BHCs) from sponsoring hedge funds and should keep the businesses distinct, Volcker said. Strict supervision enforced by capital requirements on proprietary trading, securities and derivatives should be included, he noted. Additionally, these systemic non-banks should be resolved through the resolution authority, if necessary. Volcker noted the need to "rejigger" regulation authority, as identified by the Treasury Department's proposal for a council of regulators to survey the overall financial system and identify risks. Such a council would prove ineffective, he noted, adding these supervisory authorities fall within the Fed's jurisdiction. "This is the natural function for the Federal Reserve," he said. Write to Diana Golobay.