Treasury Secretary Timothy Geithner said Thursday that giving the government the power to dismantle mammoth financial firms like Lehman Brothers will prevent future bailouts.
In a House hearing, Geithner refuted angry claims by Republicans that the proposal would create a category of firms deemed so big and influential to the broader economy that they wouldn't be allowed to fail.
"The only authority we would have would be to manage their failure," Geithner told the House Financial Services Committee.
The Obama administration and Rep. Barney Frank, the panel's chairman, want legislation that would enable federal regulators to identify and monitor big financial firms and step in to wind them down before they collapse.
Regulators have a similar authority with traditional banks but were powerless last year when investment bank Lehman Brothers and insurance giant American International Group teetered on the brink of collapse.
The government allowed Lehman Brothers to fail, helping to trigger the worst financial crisis in seven decades as nervous investors withdrew funds from money markets and credit lines froze. When it came to AIG, the Bush administration decided instead to swoop in with a hefty government bailout.
Frank, D-Mass., and Geithner said the latest proposal would prevent the government from having to decide between doing nothing and a costly rescue.
"Without the ability for the government to step in, manage the failure of a large firm and contain the risk of a fire spreading, we are resigned to repeat the experience of last fall," Geithner said.
If the bill passes the House, a list of systemically important companies wouldn't be released to the public. But these firms would eventually have to disclose to investors that they're under additional constraints.
Rep. Spencer Bachus of Alabama, the top Republican on the panel, said that any identification of a company as "too big to fail" would imply that the government would step in to rescue it. He also said the plan would put taxpayers on the hook to pay administrative costs of dissolving large firms.
Under the bill, the government would front the money to dismantle a company. If the firm doesn't have enough assets to repay the government, regulators would assess a fee to other firms with more than $10 billion in assets.
"For those who believe that those taxpayer losses would be recouped from surviving firms, I would direct their attention to the recent examples of GM, Chrysler, Fannie Mae, Freddie Mac and AIG," Bachus said.
Frank said that had the government had the power to act preemptively in these cases, a bailout might not have been needed.
At least one Democrat, Rep. Luis Gutierrez, said he thought large financial firms should be forced to prepay into an insurance-like fund.
"The fund should be set up just in case their behavior — their reckless, dangerous and risky behavior — raises its ugly head again," said Gutierrez, D-Ill.
The Federal Reserve Board agreed with Geithner that the legislation would probably prevent future bailouts. Fed Governor Daniel Tarullo said in prepared remarks that the bill "would establish the expectation that shareholders and creditors of the firm will bear losses as a result of the firm's failure."
Banks oppose a provision in the bill that puts the Federal Deposit Insurance Corporation in charge of dismantling these failing firms. Banks pay the FDIC to insure deposits, and they don't want their premiums to pay for the FDIC's new power.
"If our fund is strong and a major nonbank fails, there will be a strong temptation to unfairly raid the bank FDIC fund to pay for it," said Edward Yingling, president of the American Bankers Association, in prepared testimony.