Dr. Geithner’s Harsh Medicine

The Obama administration has proposed the most comprehensive overhaul of the nation’s financial industry since the Great Depression.  The measures, as outlined by Secretary of the Treasury Timothy Geithner, will require regulation of hedge funds for the first time and give government wide-ranging powers to seize and take apart companies that are perceived as threats to the overall economy.  The proposals are strong medicine indeed.

The measures, which require Congressional approval, are structured to entice private buyers by offering the similar supercharged leverage that prevailed during the financial boom-but one where oversight is de rigueur.   While the private sector is cutting back on its debt, the government believes that providing inexpensive financing is the best way to free up the market for illiquid debt.

The proposals give the Federal Reserve the authority to oversee the nation’s economy for signs of “systemic risk”.  The legislation will include significantly stronger requirements regarding the cash reserves and assets that institutions must have on hand to endure economic downturns.  Hedge funds, private-equity firms, derivatives and other private investment funds will be required to register with the Securities and Exchange Commission and will be subject to strict regulation.  Additionally, the government will establish a central clearinghouse to closely monitor trades in these markets.  Lastly, the administration will develop stricter requirements for money market funds so withdrawals don’t threaten the broader financial system.

Harsh medicine indeed, but the old system failed us all.  Secretary Geithner sees his proposals as a price worth paying to clean out banks’ balance sheets.  If the plan fails, it will be because banks were not willing to risk of taking a write-down and depleting precious capital.