Treasury Secretary Timothy Geithner told the Financial Stability Oversight Council that the financial system is getting stronger and safer and that much of the excess risk-taking and careless financial practices that caused so much damage has been forced out.  However, he said, "These gains will erode over time if we are not able to put our full reforms into place."

He outlined the basic framework has been laid, with new global agreements to limit leverage, rules for managing the failure of a large firm and the new Consumer Financial Protection Bureau (CFPB) up and running, and the majority of the new safeguards for derivatives markets proposed.  Geithner ticked off the major accomplishments of reform.

First, banks now face much tougher limits on risk which are critical to reducing the risk of large financial failures and limiting the damage such failures can cause.  The focus in 2012 will be "on defining the new liquidity standards and on making sure that capital risk-weights are applied consistently."

 The new rules are tougher on the largest banks that pose the greatest risk and are being complemented by other limits on risk-taking such as the Volcker Rules and limits on the size of firms and concentration of the financial systems.  These will not apply only to banks but to other large financial institutions that could pose a threat to financial system stability and this year the Risk Council will make the first of these designations.

Second, the derivatives market will, for the first time, be required to meet a comprehensive set of transparency requirements, margin rules and other safeguards.  These reforms are designed to move standardized contracts to clearing houses and trading platforms and will be complemented with more conservative safeguards for the more complex and specialized products less amenable to central clearing and electronic trading.  These reforms, the balance of which will be outlined this year, will lower costs for those who use the products, allow parties to hedge against risk, but limit the potential for abuse, the Secretary said. 

Third, is a carefully designed set of safeguards against risk outside the banking system and enhanced protections for the basic infrastructure of the financial markets: 

• Money market funds will have new requirements designed to limit "runs."
• Important funding markets like the tri-party repo market are now more conservatively structured.
• International trade repositories are being developed for derivatives, including credit default swaps.
• Designated financial market utilities will have oversight and requirements for stronger financial reserves;

Fourth; there will be a stronger set of protections in place against "too big to fail" institutions.  The key elements are:

• Capital and liquidity rules with tough limits on leverage to both reduce the probability of failure and prevent a domino effect;
• New protections for derivatives, funding markets, and for the market infrastructure to limit contagion across the financial system;
• Tougher limits on institutional size;
• A bankruptcy-type framework to manage the failure of large financial firms. This "resolution authority" will prohibit bailouts for private investors, protect taxpayers, and force the financial system to bear the costs of future crisis.

Fifth, significantly stronger protections for investors and consumers are being put in place including the CFPB which is working to improve disclosures for mortgages and credit cards and developing new standards for qualified mortgages.  New authorities are being used to strengthen protections for investors and to give shareholders greater voice on issues like executive compensation.

Geithner pointed to the failure of account segregation rules to protect customers in the MF Global disaster as proof of the need for more protections and said that the Council will work with the SEC and the Commodity Futures Trading Council on this problem.   

Moving forward, reforms must be structured to endure as the market evolves and to work not just in isolation but to interact appropriately with each other and the broader economy.  "We want to be careful to get the balance right-building a more stable financial system, with better protections for consumers and investors, that allows for financial innovation in support of economic growth." 

First, he said, we have to make sure we have a level playing field at home; that financial firms engaged in similar activity and financial instruments that have similar characteristics are treated roughly the same because small differences can have powerful effects in shifting risk to where the rules are softer.  A level field globally is also important, particularly with reforms that toughen rules on capital, margin, liquidity, and leverage, as well as in the global derivatives markets.  "In these areas we are working to discourage other nations from applying softer rules to their institutions and to try to attract financial activity away from the U.S. market and U.S. institutions." 

It is necessary to align the developing derivatives regimes around the world; preventing attempts to soften application of capital rules, limiting the discretion available to supervisors in enforcing rules on risk-weights for capital and designing rules for resolution of large global institutions.  Also, because some U.S. reforms are different or tougher from rules in other markets, there needs to be a sensible way to apply those rules to the foreign operations of U.S. firms and the U.S. operation of foreign firms.

 The U.S. also needs to move forward with reforms to the mortgage market including a path to winding down the government sponsored enterprises (GSEs.)  The Administration has already outlined a broad strategy, Geithner said, and expects to lay out more detail in the spring.  The immediate concern is to repair the damage to homeowners, the housing market, and neighborhoods.  The President spoke this week about the range of tools he plans to use.  Our ultimate goals are to wind down the GSEs, bring private capital back into the market, reduce the government's direct role, and better target support toward first-time homebuyers and low- and moderate-income Americans.

Geithner said the new system must foster affordable rentals options, have stronger, clearer consumer protections, and create a level playing field for all institutions participating in the system.  For this to happen without hurting the broader economy and adding further damage to those areas that have been hardest hit, banks and private investors must come back into the market on a larger scale and they want more clarity on the rules that will apply. 

Credit availability is still a problem and there is a broad array of programs in place to improve access to credit and capital for small businesses.  As conditions improve, it is important that we remain focused on making sure that small businesses, a crucial engine of job growth, have continued access to equity capital and credit.

Many Americans trying to buy a home or refinance their mortgage are also finding it hard to access credit, even for FHA- or GSE-backed mortgages.  The Administration has been working closely with the FHA and FHFA to encourage them to take additional measures to remove unnecessary barriers and they are making progress.  They will probably outline additional reforms in the coming weeks.

Bank supervisors, in the normal conduct of bank exams and supervision, as well as in the design of new rules to limit risk taking and abuse, must be careful not to overdo it with actions that cause undue damage to the availability of credit or liquidity to markets.

Geithner said the U.S. financial system is getting stronger, and is now significantly stronger than it was before the crisis.  Among the achievements:

• Banks have increased common equity by more than $350 billion since 2009.
• Banks and other financial institutions with more than $5 trillion in assets at the end of 2007 have been shut down, acquired, or restructured.
• The asset-backed commercial paper market has shrunk by 70 percent since its peak in 2007, and the tri-party repo market and prime money market funds have shrunk by 40 percent and 33 percent respectively since their 2008 peaks.
• The financial assistance we provided to banks through TARP, for example, will result in taxpayer gains of approximately $20 billion.

The Secretary said the strength of the banks is helping to support broader economic growth, including the more than 3 million private sector jobs created over 22 straight months, and the 30 percent increase in private investment in equipment and software.   Broadly, the cost of credit has fallen significantly since late 2008 and early 2009.  Banks are lending more, with commercial and industrial loans to businesses up by an annual rate of more than 10 percent over the past six months.  

He concluded by saying that no financial system is invulnerable to crisis, and there is a lot of unfinished business on the path of reform.  The reforms are tough where they need to be tough.  "But they will leave our financial system safer, better able to help businesses raise capital, and better able to help families finance safely the purchase of a house or a car, to borrow to invest in a college education, or to save for retirement.  And they will protect the taxpayer from having to pay the price of future crisis."