UPDATE: Treasury, Fed, SEC, FDIC On Financial Stability Board - Draft

The draft, circulated by the House Financial Services Committee on Tuesday afternoon, calls for the creation of a Financial Services Oversight Council that would be headed by the Treasury secretary. Also having votes would be the federal banking regulators, Securities and Exchange Commission, Commodity Futures Trading Commission, the Federal Housing Finance Agency, and the National Credit Union Administration.

This council, which would also include a state insurance and state banking regulator as non-voting members, would be tasked with monitoring the financial markets and identifying "financial companies and financial activities that should be subject to heightened prudential standards in order to promote financial stability and mitigate systemic risk."

The proposal is the product of extensive negotiations between House Financial Services Chairman Barney Frank (D.,-Mass.) and Treasury and White House officials. It is a key piece of the administration's broader regulatory reform effort, along with new oversight over hedge funds and derivatives, and the creation of a new consumer financial protection agency.

The latter was left off of the financial oversight council in the current draft because it does not currently exist. It will eventually become a member of the council once House and Senate lawmakers reconcile the various legislative proposals, according to a person familiar with the matter.

The measure would for the first time set out a formal structure for the government to deal with large financial firms that face failure. Policymakers have said a key problem they faced last year was no clear authority to deal with the collapse of major financial players.

The new system would task the FDIC to act as a receiver for a systemically important firm that fails. The determination to take that step would be made by the Treasury Secretary, but only after a recommendation from the firm's regulator and the Fed. Among the factors the Treasury would have to consider: " the potential to increase moral hazard" putting the firm into receivership could have.

The FDIC, acting as receiver, would have wide latitude to wind down the firm. The draft legislation states that the FDIC could purchase debt obligations, make loans or acquire any type of equity interest into the troubled firm. It could also sell or take a lien on any assets.

Importantly, the proposal states that the FDIC must use the goal of financial stability, and not the preservation of the financial company, as the determining factor for what actions it takes. The agency would have to ensure that " shareholders of a covered financial firm do not receive payment" until all claims are met, that "unsecured creditors bear losses," and that the management responsible for leading a firm to ruin are removed.

To avoid having taxpayers foot the bill in the event of a large financial firm collapsing, the measure allows the FDIC to use the sale of assets and other steps to cover the costs. If the costs exceed what the FDIC can recoup, the agency would be given a five-year period to levy assessments against the financial services industry to pay for any losses.

Firms with under $10 billion in assets would be exempted from any special assessments, and all other firms would be assessed on a graduated scale that would hit larger and more risky firms harder.

- By Michael R. Crittenden, Dow Jones Newswires; 202-862-9273; michael.crittenden@dowjones.com

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  10-27-091821ET
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