December 8, 2019

Today’s Economist: Simon Johnson: Choosing the Next Head of the Federal Reserve

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Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

The race is on to determine who will succeed Ben Bernanke as chairman of the Board of Governors of the Federal Reserve System. Mr. Bernanke’s term expires at the end of January 2014 and, while he might still decide he wishes to stay on, indications from the White House increasingly suggest that a change will be made — most likely with a preliminary decision in the next few months.

Today’s Economist

Perspectives from expert contributors.

The leading candidates are Janet Yellen, current vice chairwoman of the Fed; Timothy Geithner, former Treasury secretary and former president of the Federal Reserve Bank of New York; and Lawrence Summers, former Treasury secretary (under President Clinton) and former head of the National Economic Council (under President Obama).

None of these candidates has made or is likely to make a clear statement about the critical issue for the next decade – how the Federal Reserve should view the financial sector, particularly the various potential causes of systemic risk. This is unfortunate, because the role of the central bank has changed considerably in recent decades, and how to deal with global megabanks will be central to the macroeconomic policy agenda going forward.

In the 1960s and 1970s, the mounting threat to the economy was inflation. At the end of the 1970s, the newly appointed Fed chairman, Paul A. Volcker, and his colleagues decided to bring down inflation through tight monetary policy. This was considered highly contentious at the time, but looking back, it seems sensible.

Inflation is a regressive tax – it hits relatively poor people hardest, in part because they lack access to investments that are good hedges against inflation (like real estate and some kinds of equity). It also distorts all kinds of economic activity and makes it hard to plan for the future. Bringing down inflation was costly – higher interest rates caused a recession, with many jobs lost. But the result was a long period of relatively low inflation.

Through at least the end of the 1960s, people at the top of the Fed thought there was a stable trade-off between inflation and unemployment, so policy makers could lower unemployment by allowing inflation to creep higher. That turned out to be illusory.

Not many people argue in favor of high inflation today.

At an event in his honor last week, Mr. Volcker was interviewed by Donald Kohn (a former vice chairman of the Fed; the two of them and I belong to the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory Committee) and emphasized the way in which the policy consensus had shifted by the late 1970s. (I recommend watching the video of this interview, which should be available in a few days on the event Web site.) Mr. Volcker was characteristically modest – and also typically perceptive. When everyone on Main Street sees a problem every day, this helps concentrate the minds of people in power.

The issue today is not control over inflation. There is no sign yet that the crisis of 2008 and resulting easy monetary policy has pushed up inflation, in part because people’s expectations regarding future inflation remain remarkably low and stable.

But the post-Volcker environment of low inflation and low interest rates ushered in a period of hyper-sized finance, both in terms of financial-sector growth relative to the economy and the size of our largest financial institutions. The problems associated now with too-big-to-fail banks, broadly defined, are in part an unintended consequence of successful monetary policy in the 1980s and ’90s. Of course, financial deregulation also played a significant reinforcing role.

More than three years ago, Mr. Volcker himself proposed one of our more significant efforts at re-regulation — what is now known as the Volcker Rule, which is designed to take some very high-risk activities out of financial institutions that are central to the functioning of the economy. On Wednesday, Mr. Volcker referred to the lack of progress in putting his eponymous rule into action as a disgrace.

The problem is that the economic rise of very big banks – the only financial institutions that would be adversely affected by the Volcker Rule, which would limit their “proprietary trading” – also greatly increased their political power. The Volcker Rule was enshrined in the Dodd-Frank financial reform legislation, but our regulators are a fragmented lot, and in the details of rule-writing, the banks have played regulator vs. regulator with great skill.

More broadly, the new head of the Fed needs to be able and willing to confront the financial sector before threats become too large. Inflation was very much in everyone’s faces in the late 1970s. Inflation is often referred to as a hidden tax, but it’s relatively transparent compared with what happens with the buildup on financial sector risk.

In the boom, people working at megabanks receive very high levels of compensation. In a huge financial crash, there are bailouts – various forms of downside protection – for those people and their creditors. Everyone else has to confront a deep and nasty recession, or worse. This is even more regressive than higher inflation, but it is also less obvious than the falling purchasing power of what is in your wallet and your checking account (i.e., the result of inflation).

Richard Fisher, president of the Federal Reserve Bank of Dallas, has made clear his skepticism of our current financial system – he and Harvey Rosenblum have also made very sensible reform proposals. He would be the ideal candidate to become next Fed chair. Unfortunately, the political power of megabanks means Mr. Fisher is unlikely to be called upon. (In a debate sponsored recently by The Economist, I supported Mr. Fisher’s views and carried the readers’ vote, 82 percent to 18 percent. I doubt that this outcome will sway even the editorial policy of that magazine.)

Eventually, we will need Mr. Fisher or someone with similar views, and a president willing to nominate such a person. Before we get there, however, it seems unavoidable that another destructive credit cycle will ensue.

Article source: http://economix.blogs.nytimes.com/2013/05/30/choosing-the-next-head-of-the-federal-reserve/?partner=rss&emc=rss

Economix Blog: Simon Johnson: The Legacy of Timothy Geithner

Timothy F. Geithner, who is stepping down as Treasury secretary, with President Obama at the White House last week.Larry Downing/Reuters Timothy F. Geithner, who is stepping down as Treasury secretary, with President Obama at the White House last week.
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Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

“Too big to fail is too big to continue. The megabanks have too much power in Washington and too much weight within the financial system.” Who said this and when?

Today’s Economist

Perspectives from expert contributors.

The answer is Peggy Noonan, the prominent conservative commentator, writing recently in The Wall Street Journal.

As Timothy F. Geithner prepares to leave the Treasury Department, most assessments focus on how his policies affected the economy. But his lasting legacy may be more political, contributing to the creation of an issue that can now be seized either by the right or the left. What should be done about the too-big-to-fail category of financial institutions?

Mr. Geithner came to Treasury in the middle of a severe financial crisis, a set of problems that he helped to create and then worked hard to prevent from worsening. As president of the Federal Reserve Bank of New York, starting in 2003, he watched over – and failed to defuse – the buildup of systemic risk. In fact, the New York Fed was relatively on the side of allowing large, seemingly sophisticated financial institutions to fund themselves with more debt relative to their thin levels of equity.

This was a major conceptual mistake for which there still has not been a full accounting. In fact, blank denial continues to be the reaction from the relevant officials.

Mr. Geithner was also in the hot seat as more explicit government support for large financial institutions began in earnest in early 2008. The New York Fed brokered the sale of failing Bear Stearns to relatively healthy JPMorgan Chase, with the Fed providing substantial downside insurance to JPMorgan, against potential losses from assets they were acquiring.

Mr. Geithner also acquiesced to Jamie Dimon, the chief executive of JPMorgan Chase, allowing him to remain on the board of the New York Fed even as his bank was suddenly the recipient of very large additional subsidies (the insurance for his acquisition of Bear Stearns). This was the beginning of a deeper public realization that there had come to be too little distance between some parts of the Federal Reserve and the big banks.

For some senior officials within the Federal Reserve System, the appearance of this potential conflict of interest was a cause for grave concern. Unfortunately, their concerns were ignored by the New York Fed and by leadership at the Board of Governors in Washington. The result has been damage to the Fed’s reputation and an unnecessary slip toward undermining its political independence.

From March 2008, when Bear Stearns almost failed, through September 2008, very little was done to reduce the level of risk in the financial system. Again, Mr. Geithner must bear some responsibility.

In fall 2008, Mr. Geithner worked closely with Henry Paulson – Treasury secretary at the time – in an attempt to prevent the problems at Lehman Brothers from spreading. They were unsuccessful, in fairly spectacular fashion. The failure to anticipate the difficulties at American International Group must stand out as one of the biggest lapses ever of financial intelligence – again, a responsibility in part of the New York Fed (although surely other government officials share some blame).

As the problems escalated, Mr. Geithner came to stand for providing large amounts of unconditional support for very big banks – including Citigroup, where Robert Rubin, his mentor, had overseen the dubious hiring of a chief executive and more general mismanagement of risk. (While a director of Citigroup, Mr. Rubin denied responsibility for what went wrong.)

Rather than moving to change management, directors or anything about the big banks’ practices, Mr. Geithner favored more financial assistance – both from the budget (through various versions of the Troubled Asset Relief Program), from the Federal Reserve (through various kinds of cheap loans) and from all other available means, including insurance for private debt issues provided by the Federal Deposit Insurance Corporation.

In official discussions, Mr. Geithner consistently stood for more support with weaker (or no) conditions. (See “Bull by the Horns,” by Sheila Bair, former chairwoman of the F.D.I.C., for the most credible account of what happened.)

Mr. Geithner’s appointment as Treasury secretary in January 2009 allowed him to continue to scale up these efforts.

In retrospect, what helped stem the panic was the joint statement of Feb. 23, 2009, issued by the Treasury, the F.D.I.C., the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Reserve, that included this statement of principle:

The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses. The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.

Mr. Geithner is often given credit for pushing bank stress tests in spring 2009 as a way to back up this statement, so officials could assess the extent to which particular financial institutions needed more loss-absorbing equity. But such stress tests are standard practice in any financial crisis.

Much less standard is unconditional government support for troubled banks. Usually such banks are “cleaned up” as a condition of official assistance, either by being forced to make management changes or being forced to deal with their bad assets. (This was the approach favored by Ms. Bair when she was at the F.D.I.C.; her book lays out realistic alternatives that were on the table at critical moments. The idea that there was no alternative to Mr. Geithner’s approach simply does not hold water.)

Any fiscally solvent government can stand behind its banks, but providing such guarantees is a recipe for repeated trouble. When Mr. Geithner was at Treasury in the 1990s and Mr. Rubin was Treasury secretary, the advice conveyed to troubled Asian countries – both directly and through American influence at the International Monetary Fund – was quite different: clean up the banks and rein in the powerful people who overborrowed and brought the corporate sector to the brink of financial meltdown.

In Mr. Geithner’s view of the world, the 2010 Dodd-Frank financial reform legislation fixed the problem of too-big-to-fail banks. Outside of Treasury, it’s hard to find informed observers who share this position. Both Daniel Tarullo (the lead Fed governor for financial regulation) and William Dudley (the current president of the New York Fed) said in recent speeches that the problems of distorted incentives associated with too big to fail were unfortunately alive and well.

Ironically, despite the fact that the Obama administration failed to rein in the megabanks and allowed them to become larger and arguably more powerful, this has not helped the Republicans in electoral terms.

As Ms. Noonan puts it bluntly: “People think the G.O.P. is for the bankers. The G.O.P. should upend this assumption.”

This is a significant opportunity for anyone with clear thinking on the right – someone looking for a Teddy Roosevelt trustbusting or Nixon-goes-to-China moment. Again, Ms. Noonan gets it right: “In this case good policy is good politics. If you are a conservative you’re supposed to be for just treatment of the individual over the demands of concentrated elites.”

Recall that some grass roots conservatives are already there: House Republicans initially voted down TARP, the former presidential candidate Jon Huntsman’s plan to end too big to fail received widespread applause from many Republicans and a number of influential commentators, including George Will and Ms. Noonan, have advocated ending too big to fail.

This would play well in the Republican presidential primaries – and even better in the general election. Watch PBS “Frontline” on Jan. 22 for an articulate presentation of why serious potential financial crimes were not prosecuted during the first Obama administration, and think about how to turn these facts into political messages.

A smart candidate could even mobilize plenty of financial-sector support in favor of breaking up or otherwise restricting the too-big-to-fail financial entities. The megabanks have very few genuine friends.

The lasting legacy of Timothy Geithner is to create the perfect electoral issue for Republicans. Will they seize it?

Article source: http://economix.blogs.nytimes.com/2013/01/17/the-legacy-of-timothy-geithner/?partner=rss&emc=rss

DealBook: Plan B Considered for Money Market Fund Rules

Timothy F. Geithner, the Treasury secretary.Mario Anzuoni/ReutersTimothy F. Geithner, the Treasury secretary.

After the failure of one effort to overhaul a major part of the mutual fund industry, top government officials worked on Thursday to find alternative ways to rein in what they see as a systemic threat to the financial system.

Treasury Secretary Timothy F. Geithner and other top regulators were given sweeping powers after the 2008 financial crisis that would allow them to force new rules on money market funds, a popular type of mutual fund that has taken some of the blame for the crisis. On Wednesday evening, the head of the S.E.C., Mary L. Schapiro, unexpectedly announced that she was calling off her agency’s long-running effort to change rules for money funds.

Mr. Geithner and fellow regulators had urged the S.E.C. to act and could now use their new authority to shift oversight of the money market fund industry away from the S.E.C., a move that has few precedents. But after being surprised by the suddenness of the S.E.C.’s decision, numerous agencies were huddling to discuss whether they could carry out such bold moves or would have to rely on more modest alternatives, people with knowledge of the deliberations said.

Regulators and advocates of change were also dealing with the likelihood that an overhaul will now be much more difficult to achieve.

“We’re in new territory,” said John Rogers, the chief executive of the CFA Institute, and a member of the recently formed Systemic Risk Council, a body of former regulators and business leaders studying financial reform. “It’s going to take awhile for the dust to settle from this particular chapter, and for us to get to a new one.”

Money market funds, which hold $2.6 trillion and make short-term loans to governments and banks, are usually stable. But they are vulnerable to runs. When one large fund got into trouble in 2008, mass withdrawals occurred at others. This deprived the financial system of cash at a critical time, prompting the Federal Reserve and the Treasury Department to bail out the money funds.

Ms. Schapiro, the S.E.C. chairwoman, circulated a proposal earlier this summer that would have forced the funds to start keeping a capital buffer against losses, or to let their shares float like regular mutual funds, instead of being fixed at $1 a share.

The backers of the S.E.C.’s reforms said they would reduce the chance of money fund panics. The industry, though, waged a fierce lobbying campaign against Ms. Schapiro’s proposal. The fund managers, including Fidelity, Vanguard and Charles Schwab, have said that the funds are safe from runs because the S.E.C. in 2010 made them hold safer assets and provide more information to investors. They argue that further changes would lead many investors to exit the funds.

After Ms. Schapiro determined Wednesday that she had not won backing for her plan from a majority of the five-member commission, she called for other regulators to impose reforms on the industry.

The most obvious next step would be for a council of top regulators, the so-called Financial Stability Oversight Council, to vote on designating money market funds as systemically important, which would pave the way for stricter regulations.

The collapse and bailout in 2008 of the insurance company American International Group inspired the formation of the council. One reason A.I.G. was able to build up large risky positions was that it operated under weak and fragmented regulations. To prevent such situations, the Dodd-Frank financial regulation law set up the council and gave it the power to bring a financial company or product under greater oversight if it looked systemically risky.

The council, which includes Ms. Schapiro, Mr. Geithner and the Federal Reserve chairman, Ben Bernanke, has voted in its last two annual reports to support changes for money market funds along the lines Ms. Schapiro advocated. Designating money market funds as systemically risky would require agreement from at least two-thirds of the council’s 10 voting members.

Several people with knowledge of the issue said that the prospect of a vote by the council had been used in recent weeks as a threat to gain support for new regulations among S.E.C. commissioners. But now that the council is confronted with the possibility of an actual vote, the difficulty of forcing changes on the funds is becoming clearer to advocates and opponents alike.

The problem with the option of designating the money fund industry as systemically important and therefore deserving of regulation is that it would send the issue back to the S.E.C. to draw up new regulations. The commissioners could still fail to agree on rules.

Alternatively, the council has the power to designate specific money funds or fund managers as systemically important. That would shift regulation of those funds to the Federal Reserve.

Any decision could take three to four months, and once approved, a fund manager could ask for a judicial review. This timing could stretch the process past the November elections, which may put new regulators into power.

“It’s not a slam dunk at all, and nor should it be,” said Senator Pat Toomey, Republican of Pennsylvania. Mr. Toomey opposed Ms. Schapiro’s proposed regulations.

Dennis Kelleher, the president of Better Markets, a lobbying group that has supported reforms, doubts the resolve of many regulators to follow through on their push for change. He says he thinks the odds of the council taking strong action “are close to zero.”

Regulators are also looking at narrower steps that individual agencies can pursue.

The Federal Reserve could limit the ability of banks to borrow from money market funds — this would reduce one of the riskiest holdings at many funds. The Fed could also make banks that run money market funds hold capital to protect against losses in the funds.

Ms. Schapiro’s defeat this week “will inform a pretty broad range of potential actions and reactions,” said one person with knowledge of the council’s thinking.

A Treasury spokeswoman, Suzanne Elio, said, “Treasury is in the process of consulting with the Federal Reserve Board, the Securities and Exchange Commission and other regulatory agencies to consider the appropriate next steps to reduce risks to financial stability from money market funds.”

Daniel Gallagher, an S.E.C. commissioner who opposed Ms. Schapiro’s plan, said that he did not want to surrender authority to the council of regulators and that he would continue pushing S.E.C. staff to study the potential impact of any changes.

“We have primary jurisdiction over these products, and regardless of whether other regulators think they need to take action, we need to continue to pursue this issue,” said Mr. Gallagher.

Whatever the path forward, regulators are likely to face determined opposition from the mutual fund industry and companies like Federated Investors, which gets nearly half its revenue from money market funds. J. Christopher Donahue, Federated’s chief executive, said his company would continue to resist further changes. “The idea that this means total victory is just not true,” he said. “To us this is a continuing effort.”

Article source: http://dealbook.nytimes.com/2012/08/23/in-effort-to-curb-money-market-funds-a-plan-b-is-considered/?partner=rss&emc=rss

Economix Blog: Simon Johnson: Huntsman’s Warning on ‘Too Big to Fail’

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Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The idea that big banks damage the broader economy has considerable resonance on the intellectual right. Thomas Hoenig, the recently retired president of the Federal Reserve Bank of Kansas City, has been our clearest official voice on this topic. And Eugene Fama, father of the efficient markets view of finance, said on CNBC last year that having banks that are “too big to fail” is “perverting activities and incentives” in financial markets — giving big financial firms “a license to increase risk; where the taxpayers will bear the downside and firms will bear the upside.”

Today’s Economist

Perspectives from expert contributors.

The mainstream political right, however, has been reluctant to take on the issue. This changed on Wednesday, with a very clear statement by Jon Huntsman in The Wall Street Journal on regulatory capture and its consequences. Before the 2008 financial crisis, he wrote, “the largest banks were pushing hard to take more risk at taxpayers’ expense.” And now, he added:

More than three years after the crisis and the accompanying bailouts, the six largest American financial institutions are significantly bigger than they were before the crisis, having been encouraged to snap up Bear Stearns and other competitors at bargain prices. These banks now have assets worth over 66 percent of gross domestic product — at least $9.4 trillion, up from 20 percent of G.D.P. in the 1990s. There is no evidence that institutions of this size add sufficient value to offset the systemic risk they pose.

This message could work politically, for five reasons.

First, for anyone on the right of the political spectrum who thinks at all about the issues, this is a coherent and appealing position. Mr. Fama had it exactly right when he said, in the same interview that “too big to fail” “is not capitalism; capitalism says — you perform poorly, you fail.”

“Too big to fail” is not a market-based concept; it’s a government subsidy scheme — of the most inefficient and dangerous kind.

This is exactly Mr. Huntsman’s theme: “Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail. There is no reason why banks cannot live with the same reality.”

Second, serious senior figures within the Republican Party have long been pointing in this direction. In 2009, for example, former Treasury Secretary Nicholas Brady said, “First we should just come out and say it: the financial system that led us to the brink of disaster is broken.” And former Secretary of State George P. Shultz has emphasized that we should “make failure tolerable,” suggesting, for example, “an escalating schedule could be required of necessary capital ratios geared to size and matched with escalating limits on leverage.”

Republicans like to discuss who is and is not a true Republican. How can any true Republican condone the subsidies that underpin our biggest financial companies today?

Third, mainstream financial thinking is in exactly the same place, in terms of asserting that capital requirements for big banks should be much higher. On this issue I refer you, as always, to the work of Anat Admati and her colleagues at Stanford University.

Mr. Huntsman’s position is in alignment with the strongest possible technical thinking, but he has also found a direct and easy way to communicate the right political message. Higher capital requirements for big banks are a great idea; they should help prevent financial disaster. But when such disaster occurs, we need financial institutions that can actually fail — with losses to creditors — without bringing down the entire system. Anything “too big to fail” is simply too big.

Fourth, political Republicans who favor the status quo with regard to megabanks are going to have a hard time justifying that position — including in a confrontational debate format. (Mr. Huntsman declined to participate in this week’s debate among the Republican candidates, but is likely to spread his “too big to fail” message as he campaigns at town hall meetings in New Hampshire.)

In particular, Mitt Romney is very vulnerable on this issue, as he has already lined up so much support from among the biggest banks. Presumably the prospect of Wall Street donations is enough to deter some Republicans (and many Democrats) from confronting the issue of “too big to fail.” But if Mr. Romney is already far ahead is this fund-raising category, there is much less to lose. And his donations must make it harder for him to explain exactly how he would ensure that even one megabank could fail.

It’s not enough just to wish that big banks could fail or to promise not to support them next time. This is not a credible commitment — and the “resolution authority” created under the Dodd-Frank regulatory legislation is a paper tiger with regard to winding down the biggest banks. If the choice is global economic calamity or unsavory bailout, which would you — let alone any Republican president — choose?

Mr. Huntsman has joined the dots. There are various ways to directly address and remove the implicit subsidies that the largest banks receive. Bloated size and excessive leverage can be effectively taxed. As he said:

Eliminating subsidies would encourage the affected institutions to downsize by selling off certain operations or face having to pay the real costs of bailouts. We need banks that are small and simple enough to fail, not financial public utilities.

Fifth, the euro zone is on the verge of calamity in large part because its members built very large banks with huge implicit subsidies, and this facilitated an irresponsible accumulation of public sector debt.

During the Dodd-Frank debate last year, we heard repeatedly from people — including senators on both sides of the aisle — who believed that reducing the size of our largest banks would somehow put the rest of our private sector at a disadvantage.

Who now would like to emulate in any way the disaster that the Europeans have brought upon themselves? Mr. Romney, please explain how you would prevent our largest banks from becoming ever larger and taking on more risk, and, as they did, continuing the reckless buildup of debt throughout the global economy.

Article source: http://feeds.nytimes.com/click.phdo?i=2ec1919a17003a3d928f7995b538e38c

DealBook: Regulator: Wall Street Not Too Big to Fail

3:22 p.m. | Updated

Michael H. Krimminger, the Federal Deposit Insurance Corporation's general counsel.Daniel Barry/Bloomberg NewsMichael H. Krimminger, the Federal Deposit Insurance Corporation’s general counsel.

Bailouts are no longer an option for Wall Street, a top Federal Deposit Insurance Corporation official told Congress on Tuesday.

Michael H. Krimminger, the F.D.I.C.’s general counsel, said in testimony before a House Financial Services Committee panel that regulators now have “the tools to end too big to fail.”

His position is a sharp turnaround from 2008, when the nation’s economy teetered on the brink of collapse. At the time, Washington enacted a $700 billion bailout for banks, the automotive industry and the giant insurer American International Group. Policymakers argued that they had no choice but to rescue the firms because they were so large and interconnected that their collapse would have caused the nation’s economic downfall.

“Such a presumption reduced market discipline and encouraged excessive risk-taking by firms,” Michael S. Barr, a former assistant Treasury Department secretary who is now a law professor at the University of Michigan, told the committee.

In the aftermath of the financial crisis, Mr. Barr was a leading architect of the Dodd-Frank Act, which aimed to rein in derivatives trading, mortgage securities and other risky Wall Street businesses.

The law, according to Mr. Krimminger, ended the era of bailouts, too.

“There is no statutory authority in the Dodd-Frank Act for us to bail out a failed financial institution.” he told lawmakers.

Instead, Dodd-Frank created the Financial Stability Oversight Council, a panel of regulators who will keep an eye on the nation’s biggest and riskiest companies. The council will designate specific financial firms — including mutual funds, insurance companies and hedge funds — that pose a systemic risk to the financial system. These firms, and banks like Goldman Sachs that have more than $50 billion in assets, will face tougher federal oversight and higher capital requirements.

The so-called systemically important financial institutions, or SIFIs, must also create a “living will” that spells out how the firms could be unwound through bankruptcy if they fall on hard times. And if the F.D.I.C. or Federal Reserve concludes that a firm’s plan is insufficient, the regulators may force the company to shed some of its riskier assets or operations, according to Mr. Krimminger.

The plan, regulators say, will prevent a repeat of the chaotic Lehman Brothers bankruptcy.

“Resolution plans are essential to ending too big to fail,” Mr. Krimminger said. “These plans will provide the analysis, information and advanced planning that was lacking in 2008.”

But some Republicans and financial industry executives say that labeling a company as “systemically important” only reinforces the too-big-to-fail problem. Others note that when complicated and huge institutions file for bankruptcy, as in the case of Lehman, markets can panic.

Dodd-Frank does offer an alternative: “orderly liquidation authority.” Under the law, the F.D.I.C. has receivership power over firms that are on the brink collapse, similar to the agency’s role when a local bank fails.

Critics contend that the process would give the government the arbitrary authority to decide when a firm lives and dies. Some also say it will force a fire sale of a failing firm’s assets.

But Mr. Krimminger reassured lawmakers that the failed firm’s shareholders and creditors would bear the brunt of the losses, protecting taxpayers from another massive bailout. The government would remove the firm’s executives, and claw back some of their compensation.

“This would be critical to avoid a future financial meltdown,” he said.

Article source: http://feeds.nytimes.com/click.phdo?i=cc7dfc3cd1c812c1b0df6a64624419d5