The Federal Reserve should lose its authority to bail out big, failing financial firms like AIG and Bear Stearns under proposed reforms aimed at limiting the collateral damage from such failures, U.S. Treasury Secretary Timothy Geithner said on Thursday.
Geithner, in testimony to the U.S. House of Representatives Financial Services Committee, said the Fed should keep its ability to act as an emergency lender of last resort, but only to solvent firms in times of severe stress in financial markets -- with Treasury consent.
Any firm that puts itself in a position where it cannot survive without special assistance from the government must face the consequences of failure, Geithner said. The proposed resolution authority would not authorize the government to provide open-bank assistance to any failing firm.
Geithner said a bill by the Financial Services Committee's chairman, Representative Barney Frank, meets the tests for key elements of a resolution authority that the Obama administration would like to see passed.
It is a comprehensive coordinated answer to the moral hazard problem and does not provide any implicit guarantees for financial institutions, he said.
We cannot put taxpayers in the position of paying for the losses of large private financial institutions, Geithner said. We must build a system in which individual firms, no matter how large or important, can fail without risking catastrophic damage to the economy.
Geithner said large failing firms should be put into a receivership managed by the Federal Deposit Insurance Corp that would seek to unwind, dismantle, sell or liquidate the firm in an orderly way where losses would be borne by shareholders and creditors of the firms.
The costs of such shutdowns would be borne by other large financial firms, imposed afterward, Geithner said. This would eliminate a standing insurance fund that creates expectations that the government would step in to protect creditors and shareholders.
Regulators also must impose tougher capital and liquidity standards on large firms that take on more risk, Geithner said, to reduce the probability of a larger firm experiencing financial distress.
But Geithner said there would not be a set list of large firms held to higher standards, adding that the government did not want to provide a false impression that such firms would be protected from failure by the government in times of stress.
(Reporting by David Lawder; Editing by Andrea Ricci)