December 8, 2008
On account of the financial market turmoil and current economic crisis, Congress and the new Administration will be introducing legislation next year to restructure the financial services industry and system and to further regulate the activities, products and services provided by financial services companies. It is anticipated that this legislation could impact all financial companies, including those in the banking, securities, insurance, investment company, private equity, lending, derivatives and commodities industries.
In connection with these developments, the Gibson, Dunn & Crutcher Financial Institutions, Public Policy, Securities Regulation and other Practice Groups will be analyzing and assessing these legislative initiatives and the issues raised by financial system regulatory reform. For example, significant changes have already begun to occur that will affect this area. Several major investment banks have become or intend to become bank holding companies or subsidiaries of such companies.
As a result, these organizations will become subject to the consolidated supervision, regulation, and enforcement authority of the Federal Reserve Board. Likewise, several insurance companies have or will acquire thrifts and become similarly regulated as savings and loan holding companies by the Office of Thrift Supervision.
To assist in understanding the potential scope of this legislation and the regulatory restructuring and reform that may occur, at the end of this update, we have listed with links certain Congressional testimony and agency speeches. These remarks provide a sample of the perspectives of various federal regulators regarding areas that will be or have the potential to be addressed in connection with financial services reform. We have also included below certain excerpts of interest from such testimony and speeches.
1. Treasury Secretary Henry M. Paulson, Jr., Remarks at The Ronald Reagan Presidential Library, November 20, 2008.
http://www.treas.gov/press/releases/hp1285.htm. In his remarks, Secretary Paulson states:
U.S. Regulatory Reform Recommendations
In our [U.S. regulatory] model, a market stability regulator would have authority to review any systemically important financial company, and to look for problems anywhere in the financial system in order to protect against systemic risk. Our continuing challenge has been what to do about non-depository institutions that may be too big or too interconnected to fail. We need a mechanism, essentially an amendment of the federal bankruptcy system, for the orderly wind-down of such institutions. Also, to ensure the market stability regulator can fulfill its role, large, systemically-important institutions, including hedge funds, should be required to have a charter that would permit some type of oversight.
Similarly, any financial product whose market size presents a systemic issue should be subject to regulatory oversight. . . . Transparency must be a higher priority. . . . And we must conduct a wholesale review of the originate-to-distribute securitization model, because for every significant financial product each party in the product chain must bear certain responsibility or potential risk.
We must address those aspects of our system that reinforce rather than counterbalance cycles; regulators and ratings agencies often take actions after a problem emerges that exacerbates the cycle.
And policymakers and regulators must examine financial services industry compensation practices. Given their role in supporting and sustaining U.S. economic activity, financial institutions’ compensation practices should not encourage unsafe and unsound risk taking or reward failure.
Under a new framework, which includes market infrastructure, transparency and wind-down authorities, we could achieve again the proper balance between market discipline and regulatory oversight, and no institution should be deemed to be too interconnected or too big to fail.
2. Federal Reserve Board Chairman Ben S. Bernanke, at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, Jackson Hole, Wyoming, August 22, 2008, Reducing Systemic Risk.
http://www.federalreserve.gov/newsevents/speech/bernanke20080822a.htm. Chairman Bernanke states:
Strengthening the Financial Infrastructure
An effective means of increasing the resilience of the financial system is to strengthen its infrastructure. For my purposes today, I want to construe "financial infrastructure" very broadly, to include not only the "hardware" components of that infrastructure–the physical systems on which market participants rely for the quick and accurate execution, clearing, and settlement of transactions–but also the associated "software," including the statutory, regulatory, and contractual frameworks and the business practices that govern the actions and obligations of market participants on both sides of each transaction.
Of course, like other central banks, the Federal Reserve continues to monitor systemically important payment and settlement systems and to compare their performance with international standards for reliability, efficiency, and safety. Unlike most other central banks, however, the Federal Reserve does not have general statutory authority to oversee these systems. Instead, we rely on a patchwork of authorities, largely derived from our role as a banking supervisor, as well as on moral suasion, to help ensure that the various payment and settlement systems have the necessary procedures and controls in place to manage the risks they face. As part of any larger reform, the Congress should consider granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems.
Yet another key component of the software of the financial infrastructure is the set of rules and procedures used to resolve claims on a market participant that has defaulted on its obligations.
A possible approach would be to give an agency–the Treasury seems an appropriate choice–the responsibility and the resources, under carefully specified conditions and in consultation with the appropriate supervisors, to intervene in cases in which an impending default by a major nonbank financial institution is judged to carry significant systemic risks.
A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails.
A Systemwide Approach to Supervisory Oversight
Going forward, a critical question for regulators and supervisors is what their appropriate "field of vision" should be. Under our current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation. An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well.
In my view, making the systemic risk rationale for guidances and reviews more explicit is certainly feasible and would be a useful step toward a more systemic orientation for financial regulation and supervision.
3. Federal Reserve Bank of New York, Timothy F. Geithner, President and Chief Executive Officer, Testimony before the Committee on Financial Services, U.S. House of Representatives, Systemic Risk and Financial Markets, July 24, 2008. http://www.newyorkfed.org/newsevents/speeches/2008/gei080724.html. In his testimony, Mr. Geithner states:
Looking forward, the United States will have to undertake substantial reforms to the framework of policy, regulation and oversight of the financial system.
The Role of the Federal Reserve
First, the Fed has a very important role today, working in cooperation with bank supervisors and the SEC, in establishing the capital and other prudential safeguards that are applied on a consolidated basis to the institutions that are critical to the proper functioning of financial markets.
Second, the Fed, as the financial system’s lender of last resort, should play an important role in the consolidated supervision of those institutions that have access to central bank liquidity and play a critical role in market functioning.
Third, the Federal Reserve should be granted explicit responsibility and clear authority over systemically important payment and settlement systems, and the ability to continue to encourage broader improvements in the over-the-counter derivatives markets.
Fourth, the Federal Reserve Board should have an important consultative role in judgments about official intervention where there is potential for systemic risk, as is currently the case for bank resolutions under FDICIA.
And, finally, the responsibilities for market and financial stability that are accorded the Fed in current and any future legislation will require that the Fed adopt a more comprehensive approach to financial supervision and market oversight. Given the changes in the structure of the financial system, maintaining financial stability requires us to look beyond just the stability of individual banks. It requires us to look at market developments more broadly, at the infrastructure that is critical to market functioning, and at the role played by other leveraged financial institutions.
4. Securities and Exchange Commission Chairman Christopher Cox, Testimony Concerning the Role of Federal Regulators: Lessons from the Credit Crisis for the Future of Regulation Before the Committee on Oversight and Government Reform United States House of Representatives, Thursday, October 23, 2008. http://www.sec.gov/news/testimony/2008/ts102308cc.htm. In his testimony, Chairman Cox states:
The lesson in this for legislators is threefold. . . . First, eliminate the current regulatory gap in which there is no statutory regulator for investment bank holding companies. . . . Second, recognize each agency’s core competencies. . . . Third, ensure that securities regulation and enforcement remain fiercely independent.
List of Congressional Testimony and Agency Speeches:
Testimony:
Securities and Exchange Commission Chairman Christopher Cox, Testimony Concerning the Role of Federal Regulators: Lessons from the Credit Crisis for the Future of Regulation Before the Committee on Oversight and Government Reform United States House of Representatives, Thursday, October 23, 2008.
http://www.sec.gov/news/testimony/2008/ts102308cc.htm.
Federal Reserve Bank of New York, Timothy F. Geithner, President and Chief Executive Officer, Testimony before the Committee on Financial Services, U.S. House of Representatives, Systemic Risk and Financial Markets, July 24, 2008.
http://www.newyorkfed.org/newsevents/speeches/2008/gei080724.html.
Federal Reserve Board Chairman Ben S. Bernanke, Regulatory Restructuring, Before the Committee on Financial Services, U.S. House of Representatives, July 10, 2008. http://www.federalreserve.gov/newsevents/testimony/bernanke20080710a.htm.
Federal Reserve Bank of New York, Timothy F. Geithner, President and Chief Executive Officer, Testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs, Washington, D.C., Actions by the New York Fed in Response to Liquidity Pressures in Financial Markets, April 3, 2008.
http://www.newyorkfed.org/newsevents/speeches/2008/gei080403.html.
Speeches:
Federal Reserve Board Chairman Ben S. Bernanke, At the Federal Reserve System Conference on Housing and Mortgage Markets, Washington, D.C., Housing, Mortgage Markets, and Foreclosures, December 4, 2008.
http://www.federalreserve.gov/newsevents/speech/bernanke20081204a.htm.
Securities and Exchange Commission Chairman Christopher Cox, Address to Joint Meeting of the Exchequer Club and Women in Housing and Finance, Washington, D.C., December 4, 2008. http://www.sec.gov/news/speech/2008/spch120408cc.htm.
Federal Reserve Board Vice Chairman Donald L. Kohn, At the Cato Institute’s 26th Annual Monetary Policy Conference, Washington, D.C., Monetary Policy and Asset Prices Revisited, November 19, 2008.
http://www.federalreserve.gov/newsevents/speech/kohn20081119a.htm.
Treasury Secretary Henry M. Paulson, Jr., Remarks at The Ronald Reagan Presidential Library, November 20, 2008. http://www.treas.gov/press/releases/hp1285.htm.
The Global Financial Crisis and the Regulatory Environment: Where Do We Go From Here? Thomas M. Hoenig, President and Chief Executive Officer, Federal Reserve Bank of Kansas City, November 17, 2008. http://www.kc.frb.org/home/subwebnav.cfm?level=3&theID=10033&SubWeb=6.
Federal Reserve Board Chairman Ben S. Bernanke, At the UC Berkeley/UCLA Symposium: The Mortgage Meltdown, the Economy, and Public Policy, Berkeley, California, October 31, 2008 , The Future of Mortgage Finance in the United States. http://www.federalreserve.gov/newsevents/speech/bernanke20081031a.htm.
Federal Reserve Board Chairman Ben S. Bernanke, At the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, Jackson Hole, Wyoming, August 22, 2008, Reducing Systemic Risk.
http://www.federalreserve.gov/newsevents/speech/bernanke20080822a.htm.
Office of Thrift Supervision Director John M. Reich, Remarks to the American Bankers Association Summer Meeting, July 21, 2008, Orlando, Florida.
http://www.ots.treas.gov/?p=Speeches.
Federal Reserve Board Chairman Ben S. Bernanke, At the Federal Deposit Insurance Corporation’s Forum on Mortgage Lending for Low and Moderate Income Households, Arlington, Virginia, July 8, 2008.
http://www.federalreserve.gov/newsevents/speech/bernanke20080708a.htm.
FDIC Chairman Sheila Bair, Remarks to the Exchequer Club of Washington D.C., June 18, 2008. http://www.fdic.gov/news/news/speeches/chairman/spjun1808.html.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have the issues discussed above. Please contact Christopher J. Bellini (202- 887-3693, [email protected]) in the firm’s Washington, D.C. office or the Gibson Dunn attorney with whom you work.
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