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Financial Overhaul: Will It Solve the Problems?

Everyone is aware that today’s current financial system is problematic and the Obama administration is now trying to do something about it. Last Wednesday, the government sought to gain more authority over the financial instrument referred to as derivatives. These derivatives played a significant role in the collapse of the financial market following the huge drop in home prices.

Trying to right the wrong, the administration has encouraged Congress to pass on a legislation that will permit federal oversight on the previously deregulated industry. It will enable the government to oversee various types of instruments including the credit-default swap which nearly caused American International Group (AIG) to collapse until the government bailout.

Treasury Secretary Timothy Geithner said the proposal will require derivatives to be traded on clearinghouses that are backed by capital reserves. This works similar to the capital cushions banks are required to have for when a borrower can’t make good on a loan. These, along with the new rules will be most costly for all parties including the dealers, the buyers, and the issuers. Despite its expensive price tag though, this move will force a majority of derivatives to be traded out in the open. This reduces the role of the banking system that has surrounded them in the past.

According to Geithner, the “financial crisis was caused in large part by significant gaps in the oversight of the markets”, the proposal aims to clean up the system. If it pushes through, the trading of derivatives will become more transparent. Regulators will also be authorized to limit the number of derivatives an institution is allowed to sell or hold.

In addition, the Obama administration wants to repeal important portions of the Commodity Futures Modernization Act which was implemented in the December of 2000. Previously, it was backed by Democrats and Republicans alike with heavy lobbying from Wall Street.

Fortunately, the proposed change is well-received in Congress, for the Democrats in particular. The move has long been expected. In fact, experts in the financial industry even say that it is inevitable because everyone understands that changes need to happen. Steven Elmendorf said that “the only question is how the change happens.” From the looks of things, it seems like everyone is about to find out.

Oversight Structure will become Sticker for Banks

With the result of the bank stress test finally over, the Obama administration is shifting its attention away from the major banks and into the government’s own oversight structure. According to Treasury Secretary Tim Geithner, he and President Obama want the nation to have “more simplified, consolidated oversight structure.”

Regulators are discussing the substantial changes that need to be made in the regulatory system. Geithner and the Treasury will unveil a new proposal that aims to overall the entire banking industry. This is to prevent similar financial crisis in the future.

Despite the lofty intentions of the government, there are many questions surrounding the so-called resolution authority. Essentially, this is the creation of a single but powerful agency that monitors and assesses the risks that the financial system decides to take and deal with.

Already, the concept of consolidating all agencies involved in regulatory duties has been talked about but it remains a sensitive topic. Consolidating would mean that the existing power structure will be extensively replaced. Some agencies will overlap and will need to fold under larger ones. There are only a few agencies with major supervising roles right now including the Federal Reserve, the Securities and Exchange Commission, and the Federal Deposit Insurance Corp.

Many other agencies play more specific roles. Among these agencies are the US Commodities Future Trading Commission, Office of the Comptroller of the Currency, and the Office of Thrift Supervision among others. Because of its bad decision making in the past, the Office of Thrift Supervision is being scrutinized. It was in charge of supervising IndyMac, American International Group (AIG), and Washington Mutual which are renowned institutions that have contributed greatly to the financial disaster right now.

Geithner also revealed another plan. Previously, only major US banks have gained access to the bailout money because they were “too big to fail”. Now, the Treasury Secretary plans to give these dollars to smaller banks that need help. Even banking institutions with under $500 million in assets can apply for the Troubled Asset Relief Program (TARP) if they’re struggling with their losses. Some of the money returned by the big banks will be used for the TARP.

Stress Test Results Officially Announced

After weeks of speculations and leakage, it is finally confirmed: some of the nation’s largest banks need additional capital. Federal regulators finally announced last May 7 that 10 out of the 19 banks that underwent the stress test “failed” it.

Leading the pack is Bank of America which needs an additional $33.5 billion. Meanwhile, Wells Fargo needs $13.7 and it is closely followed by GMAC LLC which needs $11.5 billion. Citigroup and Morgan Stanley need $5.5 billion and $1.8 billion respectively. Among the banks that were given a clean bill of health are JP Morgan Chase, Goldman Sachs, US Bancorp, Bank of NY Mellon, and MetLife.

In spite of the vulnerable state the banks are still in, the government is confident about the financial industry. The Obama administration believes that even if the banks are not totally out of the woods yet, it is fast getting there. Almost half of the banks that have taken the stress test passed them. Even those that didn’t were actually in better financial shape that people originally thought.

Fed Chairman Ben Bernanke expected the report to restore investor confidence. And indeed, his projection proved to be accurate. Markets have improved steadily since the results were announced with rising share prices, better liquidity, and other signs of a stabilizing market. Regulators were also happy that capital marketers were willing to fill in the holes the stress test revealed at the banks.

The stress test showed that some of the major banks required a $74.6 worth of additional capital to ensure that they can withstand worst-case scenarios. Both Morgan Stanley and Wells Fargo sold over $15 billion worth of bonds and shares the following day. On the other hand, Bank of America said that it planned to sell 1.25 billion shares when they saw that investors were positive about their relatively small shortfall.

The Obama administration is pleased with this development. This is because if the banks are able to raise the necessary capital halfway by next week, the administration would not need to ask Congress for more bailout money.

Still Unofficial: Citigroup Failed the Stress Test

Citigroup Failed the Stress Test

Making financial news headlines is the still-unofficial results of the stress test. Apparently, Citigroup may need to raise as much as $10 billion in capital in order to comply with the new standards. However, in an interview with the Wall Street Journal, the bank had argued that this may not be necessary. In fact, Citibank is currently conducting its own analysis and is expecting to find that it already has $500 million as capital safety net. But it was reported that because of Citi’s objections, the findings of the bank stress test will be delayed to May 7 which is three days later than the supposed announcement date.

Citigroup Trying to Raise Additional Cash

It is expected that Citigroup may try to get additional capital from private investors instead of the government bailout money. The New-York based bank was already given $52 billion on rescue funds last year. Under the current plan, the government can convert $25 billion of its stake for a 36 percent voting interest. If it decides to convert the remaining $27 billion, Citigroup will need to cede control. This is a scenario no one wants to ponder for the once biggest US bank.

One solution that is being pointed out is to convert $10 billion privately-held securities. It will be added to the pending exchange to bring Citigroup over the threshold required by the Federal Reserve. Other plans include selling “non-core” business such as the Nikko Cordial Securities and the Smith Barney brokerage to free up capital.

How the Stress Test Will Affect the Future Intervention

The government has previously revealed that it will not allow any of the 19 biggest banks that underwent the stress test to collapse. Those that are found to require additional capital, but are unable to acquire it, may be given additional loans. Later, the administration will reveal what “type of investor it will be in companies where it has a stake” according to the Journal.

Undeniably, the results of the stress test will be felt in the entire financial industry. It will play a big role in determining future government intervention in the financial system. After the results are announced, the banks will be given 30 days to present a plan to the government and six months to implement it.

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