New Cop on Bank Beat? Not the Fed, Try Treasury

WASHINGTON — When critics of regulatory reform say the legislation would concentrate too much power in one agency they are usually talking about the Federal Reserve Board.

Maybe they should be focusing on the Treasury Department.

Under various proposals being weighed in Congress, the Treasury could end up overseeing systemic risk, deciding when the government exercises unprecedented resolution powers over giant companies and gaining veto power over what is now the Fed's free hand to aid failing firms.

Some observers say giving the administration such a direct role in overseeing the financial markets would inject a more political calculation into the regulatory process.

But others said a higher regulatory profile makes sense for the Treasury, noting the department is already at the center of making economic policy, might be less prone than other regulators to get too close to institutions and could end up being more accountable for the smooth functioning of financial markets.

"Treasury was always going to have authority when things blow up because ultimately you are going to need the backing of the taxpayer," said Douglas Elliott, a fellow at the Brookings Institution.

Early regulatory reform proposals put the Fed in charge of regulating systemically risky, or so-called Tier 1, institutions.

But as debate has evolved, policymakers have shifted toward creating a council of regulators overseeing systemic risk; some plans would give the Treasury a key seat on that council while others would have the Treasury lead it.

The Treasury could be a less-objective steward than the Fed, which is independent from the administration.

"If you have short-run issues being decided by the political side" of the government, rather "than by the more arguably dispassionate Board of Governors, then you could have some bad decisions being made," said William Longbrake, a member of the board of directors of First Financial and an executive in residence at the University of Maryland.

But the involvement of the politically minded Treasury might have its benefits.

"Politicizing is another word for accountability and you have to have accountability in this process," said Wayne Abernathy, a former assistant Treasury secretary and now the executive director for financial institutions policy and regulatory affairs for the American Bankers Association.

"When you get to systemic risk, it is so big and so important for the whole economy, you have to have accountability. And you want to make sure whoever is doing it has the full weight and support of the president and only the Treasury secretary can do that."

Also on the table: giving the Treasury the power to decide which systemically risky firms go into receivership.

Under the administration's proposal first introduced in the spring, the Treasury — upon the recommendation of a company's primary regulator — would have the authority to appoint an agency such as the Federal Deposit Insurance Corp. to be the conservator or receiver for a systemically important nonbank.

But critics say that approach would give the Treasury too much authority to decide which firms fail and which stay afloat, and some observers expect a legislative revision to emerge this week that would reduce that power. (House Financial Services Chairman Barney Frank is said to be in consultation with the administration on a revised draft that would include changes to both the systemic risk and resolution provisions.)

Under the Treasury's initial plan, the government could provide loans or guarantees to failing firms, which some observers say gives the Treasury a blank check to keep "too big to fail" firms in operation.

"The part I disapprove of is the ability of Treasury to spend money without approval of Congress," said Phillip Swagel, a visiting professor at Georgetown University and former Treasury assistant secretary for economic policy in the last administration.

"That is a permanent supercharged" Troubled Asset Relief Program.

But others argued it would be more difficult for firms to come to the Treasury for assistance than it would be to seek a helping hand from another regulator.

"It's much harder to lobby them," said Doug Landy, a partner at Allen & Overy LLP and formerly a lawyer at the Federal Reserve Bank of New York. "They won't listen as friendly" to arguments "by the institutions that what they are doing would hurt their business."

Another potential boost to the Treasury's power would be a say in whether the Fed could use its emergency lending power under the so-called 13(3) provisions of the Federal Reserve Act.

Currently, the Fed has free reign to tap the authority when it deems it suitable, and the authority was used during the crisis to help both American International Group Inc. and Bear Stearns & Co.

The final regulatory reform package could place that ultimate decision with the Treasury.

Longbrake said the administration could use that power to strong-arm the Fed into a decision it did not support.

"If they have to get approval from somebody else, what they will have to do, as things develop, is engage in an open discussion with Treasury," Longbrake said. "You may say, 'What's wrong with that?' But you don't know what happens behind the scenes."

Landy disagreed, saying the change would only codify existing practices.

"It's probably the least important because in practice the Fed does run those decisions with Treasury," he said. "The Fed realizes if they did it without Treasury's involvement or desires it would not be as effective."

But Lily Claffee, a partner at Jones Day and a former counsel at the Treasury, said even though the Treasury was heavily involved in last year's bailouts and even condoned them, the Fed having to ask for that permission would be a dramatic shift. "Asking if you agree with me is different than 'Mother may I?' " she said.

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