It is possible that the government might have overpaid a number of banks during its initial rescue attempt of American International Group (AIG). The company was in such big trouble that the Federal Reserve Bank of New York – previously headed by Treasury Secretary Tim Geithner – that the US government had to wind down its relationships with business partners.
The Federal Reserve Bank had paid the full face value of securities so that these businesses would cancel the insurance handed out by AIG. This was an attempt to relax the AIG’s liquidity trouble. However, reports leaked that at least one company had offered to cancel the contract at less than its face value. According to Neil Barofsky, the Special Inspector General, what it means is that the government might have paid billions more than what was necessary to cancel debt insurance contracts.
Why Was AIG Bailed Out at Any Cost?
Despite these findings, some analyst cannot blame the actions of the Fed during the crisis. AIG is too interconnected with other financial and non-financial firms that its failure could push the global banking system over the edge. As it neared collapse, officials decided to step up and bailout the company with billions of dollars and government guarantee to prevent a deepening of the crisis.
Whether the bailout is good for the long-term future of AIG and the government remains to be seen. This is because after several bailout attempts, the company now holds up to $180 billion in government commitments. The Treasury Department owns about 80 percent of AIG.
The Government Still Getting Some Criticisms
Critics though aren’t content with the government’s actions. They note that AIG’s trading partners knew full well what risks they are taking when they got insurance for credit-default-swaps. These partners showed willingness to take risks based on these actions. They should have been forced to take than 100 percent value of their contracts.
Neil Barofsky said that taxpayers are unlikely to recover the money infused into AIG.
A proposal for a complete regulatory overhaul is expected to be revealed this Wednesday and the Obama administration is expecting stiff resistance to certain aspects of the proposal from banking companies. Almost all areas related to banking operations will be touched by the proposed legislation; ranging from how consumers are charged on credit card debts to how exotic financial instruments are packaged.
The outcome of Obama’s proposed financial reorganization will have a large impact on how banks operate in the future. Varying interest on different segments of the economy, from business to consumers to the government needs to be ironed out. Talks about regulatory problems will likely dominate the discussions in Capitol Hill for the succeeding months.
At the center of the regulatory plan is the “white paper” as it is referred to by the administration. In essence, it aims to provide the Federal Reserve more oversight power when it comes to dealing with the largest players. The government wants the Fed to gain the authority to break-up important companies – similar to how FDIC operates failed banks – once it becomes a threat to the overall economy. In addition, the Obama administration also wants to create a new watchdog that will scrutinize consumer products more thoroughly.
Certain lawmakers want to consolidate power to a single regulatory agency but the president does not intend to pursue this route. Instead, the administration will allow several agencies to continue their operations. In fact, the only agency that will be abolished is the Office of Thrift Supervision. If the proposed consumer agency pushes through, the number of oversight institutions in the financial industry will remain the same.
Treasury Secretary Timothy Geithner is scheduled to appear before the Senate and House panels. Many expect him to be criticized and called to answer how regulators can create a process that will not simply bailout finance companies on the brink of collapse. Lawmakers also want more responsibility on the part of the banks. The issue of giving more authority to the Federal Reserve will also be a thorny issue given its past failures and culture of secrecy.
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.
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.