Congress will likely move next year to require companies that insure credit default swaps–such as American International Group–to at least partially reserve against potential losses, according to Rep. Barney Frank, D-Mass., chair of the House Financial Services Committee.
In comments at the Consumer Federation of America's recent annual conference, Rep. Frank characterized AIG's decision to guarantee against losses on mortgage-backed securities backed by subprime loans at the holding company level as "unregulated speculation."
He said Congress is likely to pass legislation curbing speculation on CDS trading partly by imposing "some reserving authority" on the unit selling such guarantees. "Look at AIG," he said, in citing how Congress will move to place curbs on risk-taking by financial institutions.
CDS sales by AIG's Financial Products unit nearly drove the company into bankruptcy and prompted the federal government to provide up to $150 billion in bailout funds to keep AIG afloat.
He said AIG is looking at its regulated insurance entities to pay the debts of its unregulated units because it sold guarantees on mortgage-backed securities through credit default swaps "without regard to the [holding company's] ability to pay claims." He added that "we will not allow people to do that going forward."
Moreover, he said, Congress will likely move to regulate systemic risk–the sale of securities backed by mortgages and other assets–separately from regulation that moves to protect investors and consumers.
"The bullets" that caused the current problems faced by financial institutions were subprime loans, while "the gun that spread it was securitization," he explained.
He said systemic risk will be "regulated by the activity, no matter who conducts the activity," while consumer protection will be separately regulated–presumably by the entity's primary regulator.
However, Rep. Frank sought to douse speculation that Democrats–in control of the White House and both houses of Congress for the first time since 1993–will impose Draconian regulation on financial services companies. He said Democrats will not act to "stifle innovation but to contain it," predicting that 2009 will be the "best year for public policy since the New Deal."
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