The Obama administration on Thursday detailed its wide-ranging plan to overhaul financial regulation by subjecting hedge funds and traders of exotic financial instruments, now among the biggest and most freewheeling players on Wall Street, to potentially strict new government supervision.
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Geithner calls for major overhaul of financial rules
By Edmund L. Andrews and Louise Story
26 March 2009
WASHINGTON: The Obama administration on Thursday detailed its wide-ranging plan to overhaul financial regulation by subjecting hedge funds and traders of exotic financial instruments, now among the biggest and most freewheeling players on Wall Street, to potentially strict new government supervision.
The Treasury secretary, Timothy F. Geithner, outlined the plan , Thursday before the House Financial Services Committee. He said the changes were needed to fixed a badly flawed system that was exposed by the current financial crisis. Mr. Geithner, in his opening statement, called for “comprehensive reform. Not modest repairs at the margin, but new rules of the game.”
Included in the plan would be the establishment of one single agency “with responsibility for systemic stability over the major institutions and critical payment and settlement systems and activities.”
To that end, Mr. Geithner said: “Financial products and institutions should be regulated for the economic function they provide and the risks they present, not the legal form they take,” Mr. Geithner said. “We can’t allow institutions to cherry pick among competing regulators, and shift risk to where it faces the lowest standards and constraints.”
He did not provide details for how all this will work, saying that the proposals would be outlined over the coming weeks.
The plan, which would require Congressional approval, would give the government new powers over “systemically important” banks and other financial institutions that are so big that their collapse would jeopardize the economy as a whole.
The government would have the power to peer into the inner workings of companies that currently escape most federal supervision — insurance companies like the American International Group, multibillion-dollar hedge funds like the Citadel Group and private equity firms like the Carlyle Group or Kohlberg, Kravis & Roberts.
If regulators decided that a company had become “too big to fail,” as was the case with A.I.G. in September, they would subject it to much stricter capital requirements than smaller rivals and much closer scrutiny of its borrowing levels and its trading partners, or counterparties.
But the most striking new proposals, and the ones that may provoke the most heated opposition from the industry, would regulate so-called private pools of capital — hedge funds, private equity funds and venture capital funds — and the gigantic market in financial derivatives, including instruments like credit-default swaps, the insurancelike instruments that allow investors to hedge against bond defaults.
Hedge funds and private equity funds manage money for wealthy individuals and institutions like pension funds. They operate almost entirely outside the regulation of either the Securities and Exchange Commission or the Federal Reserve.
Under the administration proposal, hedge fund, private equity and venture capital fund advisers would for the first time have to register with the S.E.C. They would be required to provide the government — on a confidential basis — information on how much they borrow to leverage their investments as well as information about their investors and trading partners.
The S.E.C. would then share those reports with a new “systemic risk regulator.”
Hedge funds have generally not been implicated in the financial collapse, which stemmed primarily from reckless mortgage lending and exotic financial instruments tied to subprime mortgages.
But the hedge fund industry for years has fought even minimal federal regulation, like S.E.C. registration. Now, a growing number of lawmakers and policy makers are worried that hedge funds have become too big a part of the financial market to operate without government monitoring.
Administration officials also want to prevent a repeat of the gigantic Ponzi scheme perpetrated by Bernard L. Madoff.
John A. Paulson, a hedge fund manager who made billions by betting against the housing market, said in an interview on Tuesday that the main goal of any regulation of hedge funds should be to protect investors from frauds like that of Mr. Madoff.
“We’re for anything that protects investors,” Mr. Paulson said. While he acknowledged that some hedge funds might have relied too heavily on leverage to improve their returns, he added that “there hasn’t been one problem at all to global systemic risk in the U.S. and abroad from a hedge fund.”
Leon G. Cooperman, a longtime hedge fund manger who runs Omega Advisors, said that new regulations were not needed and that he found the call for new rules to be mere finger-pointing.
“I’m already heavily regulated,” Mr. Cooperman said, saying that his fund was subject to oversight from the S.E.C., the Commodity Futures Trading Commission, the Fed and other organizations.
“The truth of the matter is, most major hedge funds are registered with the S.E.C., they are regulated with the C.F.T.C., and they are subject to Federal Reserve margin requirements,” he said, referring to the Fed’s rules that require all investors to set aside funds when buying securities on credit. “The regulatory system is already in place. Let them enforce what they have.”
There is likely to be an even bigger fight over the proposal to regulate financial derivative products. Some derivatives, like stock options and interest rate futures, are already regulated because they are traded on exchanges like the Chicago Board of Trade.
But the administration would regulate trading in more exotic derivatives that trade privately, like the credit-default swaps that were used both to hedge against and to speculate on high-risk mortgage-backed securities. These more exotic products have been traded almost entirely in the informal, over-the-counter market that lies outside regulatory scrutiny.
The administration would require that all standardized derivatives be traded through a regulated clearinghouse. Traders would be required to provide documentation on their collateral and borrowings. They would also be subject to new eligibility requirements, and their trading and settlement practices would be subject to new standards.
But the proposals are all but certain to provoke criticism from all sides — traders who say the rules are too intrusive and policy experts who say the approach is too vague.
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