The U.S. government would gain far-reaching new powers to regulate, and even shut down, large financial firms that threaten economic stability under a draft bill released in Congress on Tuesday.
Congressional Democrats and the Obama administration agreed on the legislation, which seeks to protect taxpayers from having to pay for more bailouts, while holding financial firms to much higher capital standards.
No financial system can work effectively if financial institutions and investors operate with the belief that the government will act to protect them from the consequences of their failures, President Barack Obama wrote in a letter to Barney Frank, chairman of the House of Representatives committee on Financial Services on Tuesday.
Under the bill, the Federal Reserve could limit credit exposures, block acquisitions, restrict pay and bonuses and, in extreme cases, order bankruptcy at financial holding companies it finds severely undercapitalized.
The bill states that the Federal Deposit Insurance Corp -- already able to seize and dismantle failing banks -- could extend Treasury Department credit to solvent banks and non-bank financial firms alike to prevent financial instability.
Any losses from FDIC actions would have to be repaid by assessments on large financial companies, not taxpayers, a provision reflecting public anger over bailouts of firms such as AIG, Citigroup and Bank of America
These firms and many others got billions of dollars in taxpayer aid through a series of confused emergency actions undertaken last year by the Bush administration in response to the worst financial crisis in generations.
Obama and Democrats have been working for months on a package of proposals to tighten bank and capital market regulation, with a key goal being to prevent a repeat of the 2008 bailouts and the political uproar that followed.
It is very important that we reach agreement on comprehensive reform as soon as possible so that we can restore confidence among American taxpayers and the world, Obama wrote in his letter to Frank.
We can and we must build a stronger financial system, one that is less prone to periodic crisis, one that provides strong protections for consumers and investors, and one in which no firm is 'too big to fail', Obama said.
We cannot meet these tests with a set of small changes at the margin, he stressed.
The bill released on Tuesday aims squarely at a post-crisis market perception that the bailouts showed a handful of financial giants have become too big to fail, or are shielded from downside risk by an implicit government guarantee.
Congress authorizing the wind-down of financial institutions of all sizes is critical because it will do away with 'too-big-to-fail,' which everyone wants, said John Dearie, executive vice president for policy at the Financial Services Forum, a group of financial services firm CEOs.
The bill should clarify how troubled firms can be dealt with and what various stakeholders can expect, giving the markets the opportunity to more accurately price capital and credit provided to large financial institutions, he said.
The legislation still must undergo congressional consideration, with financial services sector lobbyists and Republicans certain to offer resistance to parts of it.
The bill would put Treasury Secretary Timothy Geithner at the head of a Financial Services Oversight Council, the latest iteration of a proposed systemic risk regulator that the administration has been developing for months.
The council would monitor threats to the financial system and recommend to member agencies ways to reduce risk at specific firms they oversee.
Neither the council nor the Fed would be allowed to release publicly the names of firms found to pose a threat to stability and slated to be held to tougher standards by regulators.
The U.S. Office of Thrift Supervision would be abolished under the bill, which would also require financial holding companies to keep so-called living wills on hand describing how they could be rapidly unwound in urgent circumstances.
FDIC extension of credit or guarantees of the obligations of distressed firms shall not include provision of equity in any form, under the language of the proposed legislation.
(Additional reporting by Ross Colvin; Editing by Eric Walsh)