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US May Not Get Control Over Financial Giants For Weeks

Wednesday, 25 Mar 2009 | 11:06 AM ET

Both the Federal Reserve and Treasury Department today are expected to send their proposals on empowering the federal government to seize financial firms whose collapse poses a systemic risk, but new legislation is unlikely to be introduced before Congress’s Easter recess, a source told CNBC.com.

The so-called winddown or resolution authority—similar to that which the FDIC now has over banks and thrifts with insured government deposits—was originally meant to be part of a broader regulatory overhaul package, which would also create a super or systemic regulator.

The latest uproar over Wall Street pay triggered by revelations about the AIG bonuses, however, prompted President Obama to ask Congress to fast track the crafting of the winddown authority as stand-alone legislation, leading to some hopes it would be ready before the recess starting April 6.

“It’s still weeks away," said a senior Congressional staffer familiar with the legislative agenda. “The most we could do before recess is a markup.” Even still, a public hearing on the matter, which is planned, still wouldn't happen until after the recess.

Both the Treasury and Fed proposals are expected to be “pretty detailed”, the source said.

The Treasury Wednesday released excerpts of its resolution authority proposal, which allows the government to put a “ firm into conservatorship or receivership and then to administer its effective, orderly reorganization or wind-down.”

In particular, "it would enable the federal agency acting as conservator or receiver to sell or transfer the assets or liabilities of the institution in question, to renegotiate or repudiate the institution’s contracts (including with its employees), and to address the derivatives portfolio, thus reducing the potential for further disruption," according to the Treasury proposal.

Under current law, the FDIC has so-called “bridge-bank authority” to take over a troubled institution with government-insured deposits. The FDIC essentially keeps the bank open for a short period of time before a pre-arranged buyer—meaning another bank—assumes control and operation.

In some cases, the government actually closes the bank and pays off depositors. The FDIC, however, does not control bank-holding companies, the parent companies of the commercial banks.

That is the responsibility of the Fed, but the central bank is only legally allowed to make the company take so-called prompt corrective action to deal with such things as capital requirements. There is no temporary status for that company if it is in trouble.

The only legal course is the bankuptcy-court process, which could entail protection from creditors or outright liquidation, neither of which would work given the complicated counter-party nature of such operations.

The Treasury proposal would apply to bank and thrift-holding companies and holding companies that control broker-dealers, insurance companies, and futures commission merchants. AIG and Citigroup both fall into those categories.

It is unclear if the Fed will make parts of its proposal public. The Treasury’s press release does not indicate what existing government entity would get the regulatory authority.

The Fed, which many consider the leading candidate for the systemic regular role, and the FDIC, have both been mentioned.

FDIC Chairman Shelia Bair last week suggested the FDIC was up to the task based on its experience dealing with commercial banks. The Treasury has also been mentioned as a possible regulator.

The regulatory vacuum first raised eyebrows about a month ago when Federal Reserve Chairman Ben Bernanke mentioned it during a presentation to the Senate Finance Committee. That led to a chorus of calls for speedy action.

Though there is broad support for such authority, some in Congress have become a bit wary about rushing through legislation.

“Somebody has to have the resolution authority; it is an unbelievable gap, no question, “ Sen. Bob Corker (R-Tenn.) told CNBC. “I want to move about it in a measured way to insure there is not some other agenda. We all need to be careful and look at the overall agenda."

The broader, systemic risk legislation will be ready by “early summer,” according to the source.

While the resolution authority legislation isn't expected to get marked up by the House Financial Services Committee prior to the recess, two other bills are: one aims to curb predatory lending, the other is a credit card holders bill of rights.

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