NEW YORK – The regulatory reform proposals before Congress do not offer “meaningful reform” and could lead to more future crises rather than averting them, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plossersaid today.
“In my view, the proposals for regulatory reshuffling, at best, miss the point of what is required for meaningful reform and, at worst, weaken the current regulatory framework,” he told the Global Interdependence Center, according to prepared text of his remarks, which were released by the Fed. “The real danger is that such proposals increase the likelihood of future crises rather than fixing the problem. Instead of elaborate restructuring, I suggest we focus on three key initiatives that will truly improve our regulatory system.”
The first change Plosser suggested was a change in bankruptcy codes especially for large nonbank financial institutions to offer “a credible resolution mechanism to allow the orderly failure of large and interconnected financial firms,” which recognizes “that no firm should be too big to fail.”
Taxpayers, he said, should not be involved and to ensure “market discipline and reduce moral hazard, the resolution mechanism must ensure that a failed firm’s shareholders are wiped out and that creditors bear losses. Most important, the resolution mechanism must be credible. Managers, owners, and creditors must believe that firms on the verge of failure will, in fact, be allowed to fail.”
Also, Plosser said, he would allow creditors, as well as the regulator, “to place a troubled financial firm into bankruptcy when it is unable to meet its financial obligations.”
Dealing with qualified financial contracts, including swaps, repos, and derivatives from firms that have been allowed to fail is another issue Plosser said needs to be dealt with, and, he added, “We also need to ensure a timely bankruptcy process, so the bankruptcy proceedings do not drag out for years.”
The second recommendation Plosser detailed is clarifying “the Federal Reserve’s umbrella supervision role for financial holding companies.” The Fed now “supervises bank holding companies and serves as umbrella supervisor of financial holding companies, while the appropriate functional regulators supervise the subsidiaries.”
He said, “I believe Congress should clarify that the Fed has umbrella supervisory powers and the responsibility to exercise them, including collecting supervisory information on the holding company and all of its subsidiaries on a routine basis.”
This would not widen the Fed’s supervisory role, he argued, but “would encourage regulators to work together to take a comprehensive look at the systemic risks of consolidated financial organizations. This thorough review of each firm would help the Fed in its macro-prudential mission to help ensure financial stability and the integrity of the payments system.”
He also suggested “a semi-annual Financial Stability Report for Congress and the public, much as it requires the Fed to submit its Monetary Policy Report. This report would also improve the transparency and accountability of the Fed’s financial oversight responsibilities, which would help ensure public trust and credibility.”
The final suggestion Plosser offered was integrating “market discipline into our regulatory structure rather than relying solely on more regulations.”
Instead of raising capital requirements, for example, he said, “regulators should marshal market forces by requiring financial firms to hold contingent capital in the form of convertible debt that would convert into equity in periods of financial stress. Contingent capital would be less costly than simply raising capital requirements, since it is triggered only under bad economic conditions, when capital is most costly to obtain. Thus, it reduces the incentives for financial firms to seek ways to evade dramatically higher capital requirements. The ready contingent capital also avoids the need for fire sales of assets to raise capital, which can exacerbate an economic downturn. And perhaps most important, it can reduce the necessity of government rescues and bailouts.”
