November 13, 2007
HP-677

Under Secretary for Domestic Finance
Robert K. Steel
Remarks before the American Enterprise Institute

Washington - Thank you very much.  Peter, thank you for that introduction and to everyone gathered here today, thank you for welcoming me.

It is a privilege to be here today at the American Enterprise Institute (AEI).  AEI has played a key role in policy-making for over sixty years, welcoming many of our most respected public servants as scholars and fellows, such as Peter, who served as General Counsel at the Treasury Department from 1981 to 1985 and White House Counsel to the President during 1986 and 1987.  These esteemed scholars and fellows have strengthened and consistently reaffirmed AEI's mission to "defend the principles and improve the institutions of American freedom and democratic capitalism."

The Administration, the Treasury Department, and Secretary Paulson share these objectives, which are reflected in their willingness to explore reform of the regulatory structure related to financial institutions, also the subject of today's panel discussions.  Private-sector financial institutions are some of the more nimble and critical contributors to this core AEI mission, to the spread of democratic capitalism.  Such institutions serve as a catalyst for economic growth in the United States, contributing over 8 percent to GDP, and have historically dominated the global financial services industry landscape.

Recognizing the need to maintain and enhance these institutions' competitiveness so as to fulfill this mission in an increasingly global environment, this past June Secretary Paulson announced that the Treasury Department would undertake a comprehensive review of the regulatory structure surrounding these institutions as part of a broader initiative focused on U.S. capital markets competitiveness. 

Today, let me first explore the genesis of this initiative and then our plan for the regulatory blueprint project. 

Globalization's Impact on Competitiveness

Upon arriving at the Treasury Department in July 2006, Secretary Paulson immediately focused on enhancing the competitiveness of U.S. capital markets.  From his previous position as the head of a major financial institution engaging in transactions all around the globe, he had experienced first-hand the changing nature of the capital markets and U.S.-based financial institutions' ability to compete in these markets. 

He chose to deliver his first speech as Secretary, not here in Washington, but in New York, reasoning:  "I chose New York for my first public remarks because this city is unquestionably the world's financial capital.  New York is home to financial institutions that are leaders in the United States and in every major market around the globe – and that is saying something!"

At that time, he pointed out, "the challenge before us now is how to achieve the right regulatory balance to allow us to be competitive in today's world while guarding against the recurrence of past abuses."  In other words, our task is to maintain U.S. preeminence in global capital markets for today and into the future.  Refining these thoughts, a few months later in November 2006, Secretary Paulson devoted a speech, again delivered in New York, to U.S. capital markets competitiveness, focusing on a number of issues impacting this competitiveness, including financial services industry regulation. 

At approximately the same time of the Secretary's arrival at the Treasury Department, the financial community actively began to debate the causes of the decline in the U.S. share of global initial public offering (IPO) dollar volume and question whether this decline signaled the diminishing competitiveness of the U.S. capital markets.   Acknowledging this trend and this question, Secretary Paulson suggested in his November speech that part of this decline likely reflected globalization and the successful dissemination of market-based ideas to other regions of the world. 

In addition to dollar volume, other IPO statistics also indicate this globalizing trend:  Many foreign economies have been rapidly transforming to market-based economies.  Of the largest 20 IPOs in 2006, 19 were foreign companies listing in foreign jurisdictions, five of which were privatizations of Chinese state-owned companies listing in Hong Kong or Shanghai.  Only one--a U.S. company--of the 20 largest IPOs listed on a U.S. exchange. 

Ninety percent of the companies going public in 2006 listed on their domestic exchanges.  The number of global IPOs more than doubled from 839 in 2002 to 1729 in 2006 (with just over 10 percent listing in the United States) and the amount invested in these offerings nearly quadrupled from $66 billion in 2002 to $246 billion in 2006.  On one level, the United States should be concerned about its declining share in global IPO dollar volume; on another level, the United States should acknowledge globalization at work and take credit for the exportation of market-based ideas to other regions. 

Although IPOs have become an often-referenced benchmark of capital markets competitiveness, to my mind focusing solely on that measurement is overly simplistic.  Instead, we should look broadly at measures that gauge our ability to foster human capital, encourage innovation, and reward efficiency.  As these conditions are met, we will continue to excel in areas such as: asset management; alternative asset management vehicles, such as hedge funds, venture capital, and private equity; technology; mergers and acquisitions; trading and execution models; and listed and unlisted derivatives. 

By most of these measurements we remain the uncontested leader.  Yet, the United States must understand these new challenges to its dominance and recognize it helped foster this foreign competitiveness.

Another figure might also demonstrate the continuing U.S. influence in this globalization and the importance of competitive U.S. financial institutions.  Seven of the top 10 financial institutions in terms of 2006 investment banking revenues are based in the United States.  Clearly symbolizing the global presence of U.S.-based financial institutions, at the same time this number should give us pause:  Could these numbers suggest a "regulatory escapism" of U.S.-based financial institutions?  That is, are U.S.-based financial institutions in some instances purposely avoiding the U.S. marketplace and seeking to do business in different jurisdictions with a regulatory climate more conducive to innovation and entrepreneurialism?  Due to the relative youth of their market-based economies, many of these jurisdictions benefit from a recently created or a newly developing regulatory structure highly homogenized with a modern and complex financial environment. 

The United States, however, does not possess the luxury of such a regulatory tabula rasa.  Over several decades the U.S. financial services industry has accumulated layers of regulation, act upon act, rule upon rule, often difficult for market participants to navigate, often exposing consumers and investors to unnecessary regulatory gaps. 

Our regulatory system has adapted to market events by expanding (sometimes in crisis moments) rather than aiming for the broader objectives of market stability, consumer and investor protection, and cost-effectiveness.  This creates a difficult environment for both regulators and regulated.  Regulators must find ways to balance appropriately these matters.

Regulatory Blueprint and the Rate of Innovation

After reflecting on these issues and hearing from investors, market participants, and public policy experts at a Treasury-hosted conference on U.S. capital markets competitiveness last spring, Secretary Paulson asked the Treasury Department to undertake a comprehensive review of the regulatory structure surrounding financial institutions and develop recommendations to modernize the U.S. regulatory system.  The goal of this regulatory blueprint is to improve the effectiveness of the regulatory structure relating to financial institutions, to find the "right regulatory balance…marry[ing] high standards of integrity and accountability with a strong foundation for innovation, growth, and competitiveness."

The Treasury Department will approach its review of the current financial services regulatory structure holistically, taking into account all financial services industry participants including insurance, securities, and futures firms, in addition to depository institutions, upon which most past Treasury Department studies have focused. 

One of the great challenges in undertaking this project will be to find a regulatory system ensuring consumer and investor protection and market stability and adaptive to the accelerating rate of innovation and complexity in the financial services industry.

Having spent 30 years in the financial services industry prior to my appointment as Under Secretary for Domestic Finance, I witnessed considerable innovation in the capital markets.  But, it was really my last few years in the financial services industry that this change accelerated at a nearly mesmerizing pace.

When I began my career in the securities industry, technology was an infrequently-discussed skill or asset, thought of only as a processing tool.  The capital markets were characterized by a nationalistic perspective and innovative vehicles, such as derivatives, were just appearing.  Compare that with today when the skilled technologist is a key actor in the industry, markets are global--operating 24/7 without boundaries--, and innovation is a skill required for success.

Technological developments have led to innovations in financial products and forever changed information flow.  As a result, some have suggested the world has flattened; it has, at the very least, become more compressed.  And, this compression will only increase with the passage of time.  

This past summer, I heard current AEI fellow and accomplished public servant, Newt Gingrich, discuss this rate of change in terms of science.  "In scientific knowledge and advancement, we are experiencing today a rate of change that is four times greater than what we did during the last 25 years--making the scale of change we will experience in the 25 year period 2006-2031 at least equivalent to what we experienced in the 100 year period 1906-2006."

I would posit that the financial services industry will experience similar accelerating rates of change.  In my final five years in the financial services industry I saw as much innovation as I saw in my first 25 years. At the same time, financial innovation and complexity, propelled forward by globalization, will increasingly expose existing fissures and gaps as well as obstructions and inefficiencies in our regulatory system. 

What does this mean for policymakers? What does this mean for the Treasury Department's blueprint?  We must work to find a regulatory system that fills these fissures and gaps, removes these obstructions, and nimbly allows for adaptation to innovation and complexity. 

To inform our work on the regulatory blueprint, the Treasury Department published a Federal Register notice last month seeking public comment on a number of topics impacting the regulation of financial institutions, including overlapping state and federal regulation, consumer and investor protection, and the strengths and weaknesses of having multiple regulators and multiple federal charters. 

The Federal Register notice also includes a section of general questions to enable consideration from a broad and integrated perspective, including questions regarding functional regulation, overall risk to the financial system, principles-based and rules-based regulation, and macro-level regulatory structure models.   

These matters should be very familiar to many of you in this audience.  The Report of the Financial Services Roundtable's Blue Ribbon Commission on Competitiveness, the subject of the panels that have preceded and will follow my remarks, addresses several of these issues.  Let me commend the Financial Services Roundtable and the Co-Chairs of the Roundtable's Commission on Enhancing Competitiveness, Richard M. Kovacevich and James Dimon, for their important work in this area, which will inform the debate as the Treasury Department moves forward.   In past speeches, the Treasury Department has highlighted several issues that the Roundtable's Report considers, including the need for finding an appropriate balance between rules-based and principles-based regulation, enhancing the dialogue between the regulator and the regulated, and a continual and comprehensive regulatory cost-effectiveness analysis.

The Treasury Department recognizes the urgency of updating U.S. regulatory structure.  Although the regulatory blueprint initiative was contemplated well before the recent market events, the regulatory gaps and fissures these events revealed underscore its necessity.  Unlike many of the regulatory studies the Treasury Department has undertaken in the past, which have been mandated by Congress, Secretary Paulson initiated this project.  We fully intend to adhere to our friend Peter Wallison's advice to "be bold" when making our final recommendations.

The reports and analysis of private sector organizations, such as the Financial Services Roundtable, reaffirm this sense of urgency.  In the past, the United States has served as a model to other economies in its ability to achieve regulation effectively protecting consumers and investors, ensuring market stability, and fostering innovation.  Federal policymakers should be obliged to work to update this model so that the United States can continue to lead a regulatory race to the top.

Conclusion

I mentioned at the beginning of my remarks that Secretary Paulson chose the setting of New York as his first speech as Treasury Secretary because of that city's being the financial capital of the world, home to several globally-dominant financial institutions.  The Secretary also suggested another reason: "I also chose to come to New York because I know from experience that the solutions to our nation's challenges are not always found in Washington." 

I am delivering these remarks in Washington, populated with federal policymakers and departments and agencies, because I know from experience that the shared responsibility between the private sector and public sector of defining and implementing the optimal solutions regarding regulatory structure lies here in the city. 

Thank you.