WASHINGTON (Reuters) - Congress should eliminate any possibility of temporary bailouts in draft legislation that would give the government power to break up troubled, systemic financial firms, a top U.S. bank regulator said on Wednesday.
Sheila Bair, chairman of the Federal Deposit Insurance Corporation, also said large firms should pay fees for risky activities, such as proprietary trading and heavy involvement in over-the-counter derivatives and structured finance.
Those fees could fund the so-called resolution mechanism that would allow the FDIC to dismantle a large financial firm in an orderly way, and could discourage financial firms from getting too big and complex, she said.
“Financial organizations ... doing a lot of proprietary trading that’s higher risk, they should pay a higher assessment,” Bair said at the Reuters Washington summit.
Bair said the Obama administration’s draft bill could be strengthened to eliminate the possibility of any “open bank” assistance, which would be another deterrent for growth.
“I think we need to make it clear it’s a resolution mechanism, not an organized bailout mechanism,” Bair said.
The administration plans to send a tougher draft bill to Congress in the coming days, but has not detailed the changes.
Bair has been a strong advocate for measures that could combat the moral hazard of “too big to fail.” She said financial firms and their investors and creditors cannot make judgments based on the belief that government will step in to insulate them from their mistakes.
The resolution regime laid out in the administration’s original proposal softened the prospect that a large firm could be subject to a government-driven dismantling if it runs into severe trouble.
That proposal would have given Treasury the power to decide whether to first try to stabilize a large failing firm before appointing the Federal Deposit Insurance Corp as a conservator to unwind the institution.
“On an individual institution basis, I do not think you should make capital investments, provide credit support, do any of that,” she said. “I think if a bank gets in trouble or any large financial organization gets in trouble because of its own mismanagement, I believe it should be put in to receivership.”
During the recent financial crisis, the government has extended hundreds of billions of dollars in taxpayer funds to a handful of institutions on the brink of failures, including American International Group (AIG.N) and Citigroup (C.N).
Watchdogs for the government’s Troubled Asset Relief Program (TARP) have said it is unlikely that taxpayers will fully recoup their investment.
Bair said the tougher resolution mechanism should, however, allow the government to provide broad assistance if financial markets are in turmoil. That exception would allow for programs like the FDIC’s debt-guarantee program for banks, which is currently be wound down.
Congress generally has been doing a “fabulous job on a bipartisan basis” to get critical financial regulatory reforms in place, Bair said.
She said, however, that lawmakers should take their time crafting bills to make sure that “dangerous ideas” do not make their way into legislation, such as loopholes that would create gaps in the policing of derivatives.
One area of great concern, Bair said, is the idea to consolidate federal bank supervision into one super-regulator.
“For these large institutions I think it’s good that there are multiple regulators looking at them,” Bair said.
Christopher Dodd, the chairman of the Senate Banking Committee, last month pledged to move forward with his effort to consolidate bank supervision into a single federal regulator, despite criticism from current bank regulators who do not want to lose power.
Dodd has not yet introduced formal legislation for his proposal, which would consolidate the Office of the Comptroller of the Currency and the U.S. Office of Thrift Supervision into one regulator. It would also strip direct bank supervision powers from the Federal Deposit Insurance Corp and the Federal Reserve, transferring those powers to the new regulator.
Bair said she cannot comprehend why lawmakers would want to cut down on the regulation of banks while the financial system is still emerging from crisis.
“Why would we want to do that? I don’t get that,” Bair said. “That’s why there’s a surreal nature to this debate.”