Treasury Secretary Timothy Geithner today proposed "new rules of the game" of regulating the financial industry: the creation of a systemic risk regulator, and hedge funds and insurance companies brought into the regulatory net. The reasoning is that unregulated entities such as insurer American International Group (AIG) were pivotal players in the current crisis.
The government moved earlier this week towards allowing government to take over ailing companies besides commercial banks whose failure might contribute to systemic risk, and the stock market rose strongly on his proposal to buy at least $500 billion of toxic assets in the Public-Private Investment Program.
Geithner made his latest suggestion, what he called "comprehensive reform" of how financial firms are regulated a week before the G20 nations are to meet in London. Commentators say that the government here would want governments abroad to take similar actions so that there would not be flight of capital from the U.S. to areas where it was easier for financial firms to operate.
Credit default swaps—essentially insurance policies against companies, business counterparts, going bankrupt—are a $60 trillion global market while hedge funds, unregulated investments, are valued at $1.5 trillion in assets.
Geithner told the House Financial Services Committee, ""The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers must end."
Repulicans have questioned giving federal regulators as much power as Geithner proposes.
Economic commentator and Harvard professor, Niall Ferguson described Geithner's plan as tantamount to "emergency wartime control over the entire financial system."
Speaking to the BBC, Ferguson agreed that regulation of insurers would be "extremely helpful," noting, for example, "AIG had lots of cheap [insurance] policies against the failure of Lehman Bros. because they thought it would never happen." Were such policies traded on an exchange, rather than sold by way of "hugger mugger" deals between individuals, AIG's "horrible" net position would have been clearer to others now reeling from its collapse, he said.
However, Ferguson, who is also a hedge fund advisor, spoke against the regulation of hedge funds, which he dubbed "a red herring." Part of the reason for the crisis is that "Regulators on both sides of the Atlantic were so busy looking for problems with hedge funds," he said. "This [crisis] was a bout the failure of enforcement of existing regulation of the capital requirements of banks."