Alan Greenspan, former Federal Reserve chairman, said Wednesday that contingent capital should be a central part of new financial regulations.
Contingent capital is debt that can be converted into equity in the future. Greenspan said that contingent capital would help shore up firms that are starting to struggle. Contingent capital, "has at least a reasonable chance of reversing the extraordinarily large 'moral hazard' that has arisen over the past year."
Lawmakers have discussed contingent capital, but they have not made it central to new financial regulations. The House passed a financial overhaul bill in December, and the Senate is headed toward a vote before Memorial Day.
Greenspan also voiced strong support for ideas backed by Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.) on how to resolve large failing financial firms. Here is Greenspan's testimony on dealing with those firms:
"Should contingent capital bonds prove insufficient, we should allow large institutions to fail, and if assessed by regulators as too interconnected to liquidate quickly, be taken into a special bankruptcy facility. That would grant the regulator access to taxpayer funds for 'debtor-in-possession financing.' A new statute would create a panel of judges who specialize in finance. The statute would require creditors (when equity is wholly wiped out) to be subject to statutorily defined principles of discounts from par ('haircuts') before the financial intermediary was restructured. The firm would then be required to split up into separate units, none of which should be of a size that is too big to fail. I assume that some of the newly created firms would survive, while others would fail. If, after a fixed and limited period of time, no viable exit from bankruptcy appears available, the financial intermediary should be liquidated as expeditiously as feasible."