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WASHINGTON — A key senator has agreed with the head of the Federal Deposit Insurance Corp. to change new Senate legislation to ensure an end to the "too-big-to-fail" approach that brought the government rushing in to bail out big banks in the financial crisis.
FDIC Chairman Sheila Bair voiced concern Friday that a provision in the Senate financial overhaul bill could be used by the Federal Reserve, invoking emergency authority, to bail out a large firm — potentially allowing for "backdoor bailouts."
The bill crafted by Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, would create a powerful Financial Stability Oversight Council to monitor the health of the financial sector and push for the breakup of large complex firms to prevent them from becoming "too big to fail."
The nine-member council, which would include the FDIC, the Treasury Department, the Fed and other agencies, could place big, interconnected financial institutions under the Fed's supervision. The legislation would give the Fed new powers to oversee nonbank financial firms so big and interconnected that their failure could threaten the economy.
"The provision (Bair) is concerned about will be removed" from the legislative draft, Dodd's office said in a statement Friday.
"If the Congress accomplishes anything this year, it should be to clearly and completely end too-big-to-fail," Bair said in an address to a convention of the Independent Community Bankers of America in Orlando, Fla. "Never again should taxpayers be asked to bail out a failing financial firm. It's time that the big players understand that they sink or swim on their own."
In a statement issued later Friday, Bair said Dodd had assured her that the provision she had criticized as a loophole will be removed.
"I look forward to working with him to achieve our mutual goal of ending bailouts and 'too-big-to-fail,'" she said.
Dodd unveiled the legislation 18 months after Wall Street's stunning failures helped plunge the nation into the worst recession since the 1930s. It is a blueprint for the biggest overhaul of financial regulations since the New Deal, giving the government unprecedented powers to split up firms that are deemed to threaten the economy and creating an independent consumer watchdog.
The bill also would force large, complex financial firms to pay insurance premiums in advance for a $50 billion fund to cover possible failures in their ranks. The fees levied up front would give the FDIC an immediate source of funds to resolve big failed institutions, so that taxpayer money wouldn't be used.
The costs of resolving smaller banks that failed would continue to be covered by the federal deposit insurance fund.
"We have just come through the greatest financial crisis since the 1930s, and for many of you it's not over yet," Bair told the community bankers in a text of her speech.
The House passed its version of overhaul legislation in December. As Dodd's package — unsupported by any Republican senators on his committee — moves closer to a vote on the Senate floor, the financial industry has ramped up its lobbying campaign against the legislation.
In a related development Friday, Sen. Jack Reed, D-R.I., said that he and Republican Sen. Judd Gregg, R-N.H., had been unable to reach an agreement on how to regulate complex financial instruments that have operated outside government oversight.
Reed and Gregg, both members of the Banking Committee, had been working for weeks to write rules for derivatives, whose value depends on an underlying asset, such as mortgages or stocks. They can help hedge against risks. But derivatives can also produce steep losses, or huge profits, if the value of their underlying asset sinks.
At issue is whether and how to write exceptions in the law for companies that use derivatives strictly as a hedge against market fluctuation, not as a speculative, profit-seeking strategy.
Industrial companies and banks have insisted on broader exemptions. Reed has argued that regulators, not Congress, should determine what those exemptions are.
Dodd had only a placeholder on paper for derivatives in his sweeping overhaul bill as he waited for Reed and Gregg to complete their negotiations. Without an agreement, the derivatives language will have to be worked out in committee next week.
Bair, meanwhile, told the bankers' gathering that community banks "are essential to the economy, but many of them are experiencing acute credit distress."
"The credit crisis, which began on Wall Street, is now mostly being felt on Main Street," she said.
Since the start of 2008, 202 banks have failed in the U.S., nearly all of them community banks. They have cost the deposit insurance fund, which fell into deficit last year, more than $58 billion. The pace of bank failures is likely to accelerate in coming months, regulators have said, as losses mount on loans made for commercial property and development.
Earlier this week, Federal Reserve Chairman Ben Bernanke urged Congress not to scale back the Fed's regulatory authority over banks, saying the central bank needs the information it gleans from its bank oversight to set interest rates and assess the health of the banking system.
Dodd's bill, while augmenting the Fed's powers to oversee big financial firms, also would strip away its power to supervise state-chartered banks and bank holding companies with assets of less than $50 billion. That would leave the Fed to oversee only 35 big bank holding companies.
Bernanke acknowledged that the Fed's past regulatory failures contributed to the financial crisis but said it has improved its oversight.
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Associated Press writer Jim Kuhnhenn contributed to this report.
