Obama Financial Regulatory Reform to Target Ailing Firms

President Barack Obama will propose shaking up U.S. financial regulation to protect the economy and improve government handling of failing firms, an administration official told Reuters Wednesday.

Intended to prevent problems like the 2008 blow-ups of Bear Stearns and Lehman Brothers and the AIG bailout, the package also will call for beefing up investor and consumer protections and closing gaps in government oversight, the official said.

“We’re working with leaders on Capitol Hill to move forward as quickly as possible,” said the official, asked about the timeline on advancing the president’s proposals.

The White House and Treasury Secretary Timothy Geithner have been working closely for weeks with congressional committees to develop regulatory reform initiatives while also dealing with the worst financial crisis in generations.

The government’s response to the Bear and Lehman failures, as well as its bailout of insurer American International Group Inc, have been severely complicated by the lack of a clear administrative procedure for handling such situations.

Obama cited the case of AIG and what he said were “outrageous” bonuses paid to its executives at the bailed-out company as a reason why the financial regulatory system needs to be overhauled.

“We’ve got to make sure that we’ve got regulations that don’t allow companies to take these huge risks that are so big that they can sort of hold us hostage,” Obama said at a town-hall style event in Costa Mesa, California.

“We can’t let them fail because that would bring the entire banking system down and hurt a lot of innocent people but on the other hand, they act irresponsibly,” he said.

Obama said the tools must be put in place so that if there is a potential bankruptcy that puts the whole financial system at risk, regulators have the authority to “sell off insolvent parts of an institution, to protect the healthy parts; to protect depositors, creditors, and other consumers.”

The Federal Deposit Insurance Corp has an established process for bringing failing banks under government control, but there is no such procedure for non-bank institutions.

The administration official said Obama will propose new tools to ensure the government can deal with important nonbank financial institutions in danger of bankruptcy and that pose risks to the global financial system.

The president will propose ways to put such firms in conservatorship or receivership, as well as powers to control their operations and to sell or transfer parts of them to reduce risky positions, the official said.

In addition, the government would be able to impose partial losses on various classes of creditors, the official said.

New rules would allow for loans, asset purchases, equity investments or liability guarantees to help stabilize firms, although steps like these would be subject to close review.

The Treasury secretary would have the authority to act only after consultation with the president and upon recommendation of two-thirds of the Federal Reserve Board, the official said.

(Reporting by Caren Bohan and Kevin Drawbaugh; Editing by Dan Grebler and Carol Bishopric)