The Treasury Department on Wednesday gave lawmakers proposals to dampen financial firms' appetites for growing to giant size and said it was one step away from giving Congress its full package of reforms.
In the wake of a two-year-old financial crisis, the Obama administration has been sending pieces of its reform ideas to Congress piecemeal as they are prepared, including Wednesday's proposals for toughening capital rules for big firms.
On Thursday, it will send up a proposal for consolidating some banking regulatory agencies into a new national Bank Supervisor and, after that, has only to propose changes for how markets in hard-to-value derivatives work.
Treasury Assistant Secretary Michael Barr said the language on derivatives reforms would be given to lawmakers -- who must draft and approve final legislation for implementing a complete regulatory overhaul -- before they leave for an August recess.
The overall trajectory of reform here I think is quite strong, Barr said, noting Congress will then have proposals covering every aspect of Treasury's proposals for creating a tougher regulatory framework that should be less subject to a meltdown such has occurred over the past two years.
Wednesday's proposals called for a new eight-member financial oversight council that would act as a coordinator for financial regulation, making the Federal Reserve the consolidated supervisor for all systemically important financial firms.
The plan would also impose stricter and more conservative standards for capital, liquidity and risk management for so-called tier one firms that are deemed to big to fail, from fear of the damage they would do the wider economy if they got into trouble.
These standards will be set with a focus on the risks that these firms could pose to the financial system as a whole, not just the risks to each institution, the Treasury said in a fact sheet that it released to explain the proposals.
Barr, in a telephone press conference, said the new capital rules effectively create a clear disincentive for firms to become so big that they reach too-big-to-fail status. The bigger they are, the more capital that they would have to put up as a guard against possible economic downturn or failure.
Big firms can gain unfair competitive advantage through growth, because they are perceived as safer bets for investors and so get access to cheaper capital and make bigger profits.
But this had disastrous consequences for the U.S. economy when several big firms got into trouble last year and had to be bailed out, at the potential cost of billions of dollars to the U.S. taxpayer.
The proposals also would require banks or other firms that securitize, or package asset-backed securities into new securities that are then resold to hold on to five percent of the credit risk. The proposal is colloquially known as making companies have skin in the game so they are less likely to try to package and resell risky securities that may fail.
Treasury said it wants to make sure that robust, consolidated supervision and regulation is applied to any company that controls a bank with the Fed in charge.
The legislation will require all financial holding companies -- including tier one financial holding companies -- to be 'well capitalized' and 'well managed' on a consolidated basis, significantly raising minimum capital standards for these firms, the Treasury said.