Treasury Secretary Timothy Geithner and Federal Reserve Board Chairman Ben Bernanke called for broad new powers to regulate the nation's financial system on Tuesday, arguing that the $170 billion rescue of AIG and the outcry over its bonuses would have never happened if the government had the right regulatory system.
Called before the House Financial Services Committee to answer for the $165 million in bonuses paid to employees of a unit of American International Group (AIG:
American International Group Inc Geithner and Bernanke tried to change the subject to a more elevated topic: How to avoid the next mess. They said Congress should broaden the authority of financial regulators to cover institutions, such as AIG, that can pose systemic risks but that aren't regulated very well.
If AIG had failed last September, the result could have been "a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs," Bernanke said.
The broader powers would give regulators tools to close down financial firms in an orderly manner and avoid a cascading collapse of financial market firms, the two officials told the committee.
Geithner said the decision to seize a financial company deemed "too big to fail" would have to have the agreement of the White House, the Fed and other top regulators.
There are several important points made above.
1.) AIG is catching a large amount of flack -- as well they should. But a central point is often lost in the stories: an AIG failure would have sent the financial system into a death spiral. What Bernanke and company want to avoid is the 1929 - 1933 period where a wave of financial failures sent the US economy into a 25% drop in GDP over a four year period. An AIG failure would have done that. As a result, they had to be saved.
2.) There is no national insurance regulator. Instead, regulation is left up to the states. This is a really stupid idea and needs to change pronto.
3.) This leads to the larger question: overall regulation of the financial industry. We're already seeing some bits and pieces of various proposals emerge:
The Obama administration is preparing an overhaul of U.S. banking rules that would force financial companies to keep more cash on hand in case their trading bets go wrong.
The bottom line is the US financial system is going to be overhauled over the next few years -- as well it should.