By Craig Torres and Christine Harper
March 4 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke’s blast at American International Group Inc. in Senate testimony yesterday suggests regulators plan further curbs on risk and concentration in the financial-services industry.
“If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG,” Bernanke told the Senate Budget Committee yesterday. The crippled insurer, which is now under government control, “exploited a huge gap in the regulatory system,” he said.
Bernanke’s remarks, echoed in separate testimony by Treasury Secretary Timothy Geithner, mean Citigroup Inc., Bank of America Corp. and Morgan Stanley can expect new restrictions as policy makers assemble what may become the broadest overhaul to financial rules since the 1930s, said Kevin Fitzsimmons, managing director at Sandler O’Neill & Partners LP in New York.
“There will either be more extensive regulation, a requirement for more capital, or a stated preference against companies getting too big, or, more likely, all of the above,” Fitzsimmons said.
The biggest obstacle may be that regulators have to keep those same conglomerates alive for now to prevent a bigger collapse in financial markets.
“AIG is a huge, complex, global insurance company attached to a very complicated investment bank, hedge fund that was allowed to build up without any adult supervision,” Geithner said yesterday during testimony to the House Ways and Means Committee.
Tumbling Shares
The Standard & Poor’s 500 Financials Index retreated 1.6 percent yesterday for its third straight drop. The index has tumbled 45 percent this year compared with a 23 percent decline for the S&P 500.
Bernanke’s comments come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul of finance, especially companies deemed vital to the stability of the financial system. After a meeting yesterday at the White House, Obama and British Prime Minister Gordon Brown said stabilizing banks is crucial to reviving economies worldwide.
“We’ve got to isolate bad assets,” Brown told reporters. “A bad bank anywhere can affect a good bank anywhere.”
The new regulatory framework may stop short of re- instating the Glass-Steagall Act of 1933, which separated commercial and investment banking and was repealed in 1999 by the Gramm-Leach-Bliley Act. Still, banks may separate their business lines in order to avoid strong regulatory scrutiny, analysts said.
Simpler Banking
“Their models for banking are going to be simpler, and less leveraged, and they are going to have a new regulator, the Federal Reserve, that is going to take a pretty conservative stance,” Fitzsimmons of Sandler O’Neill predicted. Congress has yet to determine the federal regulator that will hold such power.
Paul Volcker, chairman of Obama’s economic advisory board and a former Fed chairman, has also advocated curtailing risk- taking by systemically vital institutions.
In January, Volcker led a panel of former central bankers, finance ministers and academics known as the Group of Thirty in calling for capital limits on proprietary trading and a ban preventing large banks from running hedge funds.
Such restrictions would mean a change for Goldman Sachs Group Inc., which Chief Executive Officer Lloyd Blankfein has promoted as able to serve as an investor, adviser and financier.
Called for Distinctions
Volcker’s report also called for differentiation between commercial banks that take deposits and make loans and other institutions that are active primarily in capital markets.
“We are making a distinction between what appears to be institutions that are becoming larger and doing banking business,” Volcker said Jan. 15. “They should give their loyalty to their clients and customers. Those functions should not be carried out in the context of an institution that is carrying out very risky capital market activities.”
John Mack, chief executive officer of Morgan Stanley, said in an interview on the Charlie Rose Show on Feb. 23 that he anticipates the firm may have to restrict some of its business activities in response to new regulation.
“Without question some of the businesses that we have been in in the past are going to be curtailed,” he said.
FDIC Chairman Sheila Bair said regulators must construct a sound capital framework that will prevent a repeat of the credit crisis. She was critical of the Basel II model, which allows banks to deploy their capital on the basis of risk models.
Wrong Assumptions
The approach “assumes banks’ internal, quantitative risk estimates are reliable,” Bair told a banking conference in Washington on March 2. “To say the assumptions turned out to be wrong would be an understatement.”
The U.S. government has deepened its commitment to prevent AIG’s collapse three times since September as the company accumulated the worst losses of any U.S. company. AIG is getting as much as $30 billion in new government capital and relaxed terms on its bailout announced yesterday.
“We’re doing our absolute best in partnership with the Fed and Treasury to unwind the very issues that Chairman Bernanke is talking about in a way that preserves systemic stability and pays back taxpayers,” said Christina Pretto, an AIG spokeswoman.
Bernanke faced criticism from the Senate Budget Committee members yesterday for the rising cost of the federal rescues.
“The public has just about had it with continuous capitalization,” Senator Lindsey Graham, a Republican from South Carolina, told the Fed chairman. “Don’t underestimate how hard it is going to be for you and others to continue to print money to solve this problem.”
Bernanke said he understands why taxpayers are angry. “It isn’t fair that money is going to big corporations,” he said. “We need to think very hard as a country how we make sure this doesn’t happen again.”
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Christine Harper in New York at charper@bloomberg.net.
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