The Great Debate over how to fix the financial regulatory system in the United States has begun. Lord knows when it will ever end.
Washington lawmakers held a flurry of committee meetings last week, both in the House and Senate, to review the credit crisis and ponder what legislation might be necessary in coming months to repair the damage and ensure similar crises are better handled in the future. A parade of government officials were called on the carpet, but no real progress is likely to happen until next year, after a new administration is in the White House.
The most substantive discussions took place at a House Financial Services Committee meeting on Oct. 21. Even then, while everyone agreed that reforms are needed, there was no consensus among members about what to do.
Some committee members called for wholesale reform of the system, such as New York Democrat Gary Ackerman; he said the U.S. financial regulatory system “is broken and needs to be fixed.” Similarly, Pennsylvania Democrat Paul Kanjorski said: “Regulation is needed to prevent systemic collapse.”
Other committee members, however, cautioned against overreacting. Before Congress “rushes to overhaul all regulation, we need to do a complete autopsy of the current problem so we know exactly what went wrong and what changes could help prevent this from happening again,” Texas Republican Randy Neugebauer said.
Neugebauer and others said that as part of their plan, lawmakers must consider how the federal government “plans to work its way out of all these interventions,” referring to the $700 billion rescue plan to pump cash into flailing financial institutions. “We will need an exit strategy,” he said.
Committee members spent nearly as much time in the hearing trying to place blame as they did trying to find solutions. Lawmakers and witnesses at the hearing offered a lengthy list of culprits they said either caused or worsened the financial crisis. Chief among them was the proliferation of complex derivative financial instruments, such as credit default swaps that were poorly understood by investors and allowed to grow unchecked by regulators.
One idea discussed was whether the market for credit default swaps should be regulated. Securities and Exchange Commission Chairman Christopher Cox—who did appear in front of other lawmakers last week, but not the Financial Services Committee—has called for precisely such a move. Other concerns on Congress’ worry list are how to restructure mortgage-finance giants Fannie Mae and Freddie Mac, which were both taken over by the government in September, and whether mortgage-lending and securitization practices need tighter controls.
Rivlin
Among those called before lawmakers to offer ideas for reform was Alice Rivlin, a senior fellow at the Brookings Institution think tank and a former Federal Reserve vice chairman. Noting that recent attempts to rethink regulation of financial markets have been “derailed by ideologues shouting that regulation is always bad or, alternatively, that we just need more of it,” Rivlin told committee members: “We don’t need more or less regulation; we need smarter regulation.”
Writing the rules for financial markets “must be a continuous process of fine-tuning,” Rivlin said. As they rewrite the rulebook, lawmakers must address a number of gaps, including a failure to regulate new types of mortgages and lax lending standards, she said.
Part of the problem is that regulators failed to modernize the rules as markets globalized, trading speed accelerated, volume escalated, and increasingly complex financial products exploded on the scene, Rivlin said. She suggested the imposition of a set of minimum standards that apply to all mortgage lending, include minimum downpayments, proof of ability to repay, and evidence that the borrower understands the terms of the loan. She also favors getting rid of teaser rates, penalties for prepayment, and interest-only mortgages.
“We don’t need more or less regulation; we need smarter regulation.”
— Alice Rivlin,
Senior Fellow,
Brookings Institution
Columbia University professor and Nobel Prize-winning economist Joseph Stiglitz said reform of financial regulation must begin with a “broader reform of corporate governance.” He blamed ill-conceived executive pay policies for “excessively short-sighted behavior and excessive risk taking.”
Stiglitz called for the creation of a Financial Markets Stability Commission to oversee the functioning of the entire financial system, and a Financial Products Safety Commission that would look at individual products. “We need to have somebody sitting on top looking at the whole system, and then someone who understand each of the parts deeply,” he said.
Stiglitz also urged Congress to act quickly to keep homeowners from losing their homes with an economic stimulus package. “We are giving a massive blood transfusion to a patient who is hemorrhaging from internal bleeding, but we are doing almost nothing to stop that internal bleeding,” he said.
Spokesmen for the banking industry, during the second panel of the day, urged lawmakers to make more cautious changes to parts—but not all—of the financial system. Noting that the banking industry is already highly regulated, Edward Yingling, president of the American Bankers Association, said: “While there is clearly room for improvement in this complex system, it has functioned well” for commercial banks insured by the Federal Deposit Insurance Corp.
The biggest failures of the current regulatory system, he said, “have not been in the regulated banking system, but in the unregulated or weakly regulated sectors.” Yingling said Treasury Secretary Henry Paulson’s plan to overhaul the regulatory system (originally floated earlier this year, before the full scope of the credit crisis) would make the regulatory structure “more complicated” for individual banks.
BIG FIXES
Just some of the issues debated at the House meeting ...
Current state of the financial regulatory system, both in the United States and abroad, and ways to measure and limit risk without stifling innovations while improving market liquidity and breadth.
implications of current governmental lending and support facilities for the regulatory structure.
Proposals to improve the regulatory structure to restore confidence in financial markets and institutions through a stronger system of regulation and oversight.
The need for enhanced capital and reserve requirements for financial firms.
The adequacy of current powers and coverage of the existing regulatory structure.
Source
Archive of Financial Services Committee Hearing (Oct. 21, 2008).
“We need a regulator who has the charter to look across the economy and identify problems before they occur,” he said. Yingling called arguments that the Gramm-Leach-Bliley Act is to blame for the current crisis “misguided.”
“Gramm-Leach-Bliley had nothing to do with this,” he said. In a way, he said, the law provided “an exit because Merrill Lynch was able to be acquired by Bank of America and Goldman Sachs and Morgan Stanley were … able to get under the Fed Reserve.”
Oversight of the Overseers
Seligman
One idea that seemed to have broad support among the Financial Services Committee was voiced by Joel Seligman, president of the University of Rochester. He urged the creation of a single, select committee representing both chambers of Congress to investigate the crisis and recommend solutions to prevent gridlock among the many committees that now share oversight of financial institutions and public markets. Such a committee would be similar to ones Congress created to investigate the Sept. 11 attacks and the Iran-Contra scandal of the 1980s.
Indeed, multiple other committees also held high-profile hearings last week into the past mistakes and possible future paths of regulation. The Senate Banking Committee called numerous government officials to testify about possible remedies to home foreclosures. The House Committee on Oversight and Government Reform held one hearing about possible reforms to credit rating agencies (another idea supported by SEC Chairman Cox), but most notably also grilled former Federal Reserve Chairman Alan Greenspan about his role in letting the credit crisis metastasize. Greenspan frankly admitted that his long-held beliefs in less regulation might have been wrong.
Cox was also called to testify at that second hearing alongside Greenspan. He admitted that the SEC’s Consolidated Supervised Entities program, which let the SEC oversee investment banks on a voluntary basis, failed on multiple levels. The SEC’s Division of Trading and Markets did not question the wisdom of capital reserve standards vigorously enough, he said, and failed to consider how investment banks differ from commercial banks. (For example, they could not borrow from the Fed until after Bear Stearns collapsed last spring, sparking the crisis.)
While Cox did call for more power to the SEC and for greater disclosure to investors, most of his comments pertained specifically to the financial sector: oversight of hedge funds, investment banks, the municipal finance market, and the like. He did not make any comments that would apply to all corporate filers, such as changes to 10-K reports or corporate governance reforms.
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