HIGHLIGHTS: Geithner testifies on financial regulation reform

WASHINGTON (Reuters) - The following are highlights from the House Financial Services Committee hearing with U.S. Treasury Secretary Timothy Geithner on financial regulation reform on Thursday.

GEITHNER ON MORAL HAZARD AND SYSTEMIC RISK REGULATOR

“We have to be very careful that what we are doing does not add to moral hazard to the system. The regime has to come with clearly defined rules about prompt corrective action, as what exists for banks, so that you can constrain the discretion of the supervisor to let the situation slip to the edge of the cliff without intervention. You have to have very high thresholds for a judgment that would allow the government to put in capital, requires elaborate checks and balances to limit the discretion there, too. And you have to look at that along side what we are proposing to raise capital requirements.”

GEITHNER ON CALLS TO BAN “NAKED” CREDIT DEFAULT SWAPS:

“I know there are strong opinions on this issue, so I say this with some trepidation. My own sense is that banning naked (CDS) volumes is not necessary and wouldn’t help fundamentally in this case. It’s too hard to hard to distinguish what’s a legitimate hedge that has some economic value from what people might just feel is a speculative bet on some future outcome. If we could find a way to separate those two types of transactions from each other, we would have done that a long time ago across a whole range of financial innovations, but it is terribly hard to do. But we will listen carefully to any ideas in this area and understand why people feel so strongly about this.

“Our view is that the absolutely essential thing is that there is more capital held against these positions so we never again face the situation where those types of judgments could imperil the system.”

GEITHNER ON SMALL BANKS:

“We are going to have to look carefully at how the cost of these interventions are shared across the system. Right now in the current system, it’s fundamentally unfair because smaller banks are forced to absorb a disproportionate cost of interventions to protect the system from ... mistakes made by larger institutions. We would like to change that and put in place a fee structure that is a bit more just and fair in that context.

GEITHNER ON COSTS OF INTERVENTIONS:

“As this crisis reveals ... there are circumstances in which it is cheaper for the taxpayer over time and less damaging for the country over time for the government to take some risk in preventing greater costs not just to the deposit insurance fund but to the rest of the system. That’s a balance we have to strike.”

GEITHNER ON AID FOR AUTO, RV DEALER FLOORPLAN FINANCING:

“We’re working on it. We’ve been looking at it very carefully over the last several weeks. We’re exploring a range of options. Can’t tell you today whether we’ve found a way to solve this, but we agree it’s important. We think it would be helpful as a part of the overall solution and I’d certainly be able to tell you and your colleagues in the next couple days what we think is possible, what’s not possible.”

GEITHNER ON LEVERAGE RATE:

The suggestion for that leverage really was what the FDIC suggested, based on the ... experience they have with their existing mechanism. Now, it is substantially less leverage than banks run with today. ... What we put forward was a framework we think leaves the taxpayer much better protected than the alternatives and we’re trying again to stretch taxpayer resources prudently and use private investment effectively. ....

“We want to get the balance right. We’re not suggesting it’s perfect. Again, we want to free up credit flows.”

GEITHNER ON FDIC

“What we’re proposing to do is build on the model established for the FDIC for banks and thrifts. That model we have a lot of experience with. There’s a whole range of important checks and balances that seem to limit discretion. So the existence of this does not increase moral hazard.

“We’re basically suggesting a model which would substantially rely on the FDIC itself to run this new regime.”

GEITHNER ON WORKING WITH EUROPE ON REGULATIONS:

“Our hope is that we can work with Europeans on a global framework, a global infrastructure which has appropriate global oversight, so we don’t have a balkanized system at the global level, like we had at the national level.”

GEITHNER ON INTERNATIONAL RISK:

“Financial products and institutions should be regulated for the economic function they provide and the risks they present, not the legal form they take. We can’t allow institutions to cherry pick among competing regulators and ship risk to where it faces the lowest standards and weakest constraints. And we need to recognize that risk does not respect national borders. Markets are global and high standards at home need to be complemented by strong international standards enforced more evenly and fairly. Building on these principles, we want to work with Congress to create a more stable system and stronger tools to prevent and manage future crises.”

REP. SPENCER BACHUS ON FOREIGN BANKS AND AIG BAILOUT:

“I have been informed that AIG is now attempting to force many of its creditors that are U.S. banks to accept severe reductions of more than 70 percent on the total debt owed to them. This disparity in the treatment between foreign banks which ... were paid dollar for dollar within hours of the bailout and U.S. banks ... have yet to receive any payment and are being asked to accept 70 and 80 percent haircuts, this disparity in treatment between foreign banks and U.S. banks is very concerning to me. This morning I sent a letter to the chairman regarding this development, and hope a hearing will be scheduled ... He has assured me that he will fully cooperate.”

REPRESENTATIVE SCOTT GARRETT ON FDIC LIKE RESOLUTION AUTHORITY FOR NONBANK FINANCIAL FIRMS:

“But I think this authority needs to be really carefully structured to avoid a lot of unintended consequences. ... We could really end up doing a heck of a lot more harm than good.”

GEITHNER: FAILURE OF SYSTEM SHOWS NEED FOR NEW RULES:

“These failures have caused a great loss of confidence in the basic fabric of our financial system, a system that over time has been a tremendous asset for the American economy. To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game. The new rules must be simpler and more effectively enforced and produce a more stable system, that protects consumers and investors, that rewards innovation and that is able to adapt and evolve with changes in the financial market.”

GEITHNER ON KEY ELEMENTS OF PLAN:

“The key elements of our plan to address systemic risk are:

First, we need to establish a single entity with responsibility for systemic stability over the major institutions and critical payment and settlement systems and activities.

Second, we need to establish and enforce substantially more conservative capital requirements for institutions that pose potential risk to the stability of the financial system, that are designed to dampen rather than amplify financial cycles.

Third, we should require that leveraged private investment funds with assets under management over a certain threshold register with the SEC to provide greater capacity for protecting investors and market integrity.

Fourth, we should establish a comprehensive framework of oversight, protections and disclosure for the OTC derivatives market, moving the standardized parts of those markets to central clearinghouse, and encouraging further use of exchange-traded instruments.

Fifth, the SEC should develop strong requirements for money market funds to reduce the risk of rapid withdrawals of funds that could pose greater risks to market functioning.

And sixth, we need to establish a stronger resolution mechanism that gives the government tools to protect the financial system and the broader economy from the potential failure of large complex financial institutions.”