FROM THE OFFICE OF PUBLIC AFFAIRS

Good morning and thank you for this opportunity to speak to you about some of the challenges facing policymakers and financial institutions today.

Without question, some of these challenges did not exist, or were perhaps not first-order issues, a few months ago. Others are hardy perennials. Let me begin with two issues that have become central for us in the wake of the September 11 attacks: terrorism risk insurance and critical infrastructure protection. I will then discuss our plans for dealing with a problem that was a critical issue before September 11 and remains one today: predatory lending.

Before going further though, let me acknowledge the role that many of you played in our financial system's recovery from the terrorist attacks. Let me also acknowledge the losses you incurred. Some of you suffered damage to your own institutions or to your customers' operations. Some of you lost friends and colleagues. And the Federal Home Loan Bank of New York, of which some of you are members, lost its headquarters. Through it all, however, you contributed individually and institutionally to keeping our depository system functioning. I commend you and I thank you.

Terrorism Risk Insurance

Prior to September 11, virtually all property and casualty insurance policies -- commercial and household -- provided coverage for terrorist acts. In some sense, this was a freebie. Since the risk was thought to be quite small and there was virtually no actuarial basis for assessing the risk, the coverage was provided at no additional charge. All that changed on September 11.

Insurance companies absorbed billions of dollars of unanticipated losses that day. To its credit, the industry is stepping up to the plate and paying the resulting claims. Yet September 11 has caused a fundamental examination of what it means to insure against terrorist acts.

After September 11, insurance companies have no sense of the risk distribution associated with possible future acts of terrorism. For the moment, the uncertainty associated with terrorism risk leaves the industry unable to assess and price risk. As a result, it is not the industry that is at risk, it is the economy. Insurance companies will - and some already have - reacted to this situation by either refusing to extend coverage for acts of terrorism or seeking exorbitant premiums for such coverage. At a time when we are working hard to stimulate our economy to get it moving again, left unresolved this situation would be a harmful drag on those efforts.

It is this risk to our economy that has driven our efforts to devise a temporary solution to what we hope is a temporary problem. Without a basis upon which to price terrorism risk, insurance companies will not offer the coverage or will offer it at rates that approach their maximum loss exposure. September 11 taught us that that potential loss exposure can be quite high indeed.

Without insurance coverage for terrorism risk, the credit positions of all types of businesses will deteriorate in the market. Borrowing costs will be driven up and new construction will be difficult to finance. Certain sectors, such as energy and transportation, may be particularly adversely affected, which in turn would drive up prices and reduce production across the board. Even if some level of terrorism risk insurance were provided, drastic increases in insurance costs would lead to similar outcomes for the economy.

Thus, the Administration has been working closely with Congress, state insurance regulators, and industry to devise a temporary mechanism that would:

• Help the economy by diminishing the cost increases for insurance coverage while ensuring that terrorism risk insurance remains available to all property and casualty insurance policyholders;
• Limit federal intrusion into private economic activity; and
• Continue to depend on the state regulatory infrastructure for insurance companies.

It is important to note that these objectives are premised on a short-term intervention by the federal government, not a new, permanent presence in the market. In fact, virtually everyone involved agrees that whatever solution we decide upon should have a clear exit strategy for the government and should encourage the insurance industry to build capacity to insure against terrorist acts as the government recedes from the market.

Nearly six weeks ago, Treasury Secretary O'Neill presented Congress with the Administration's proposal for dealing with this market problem. Since then, we have been working with the Congress to find an agreeable solution. While we have achieved a broad, bipartisan consensus that this is a critical situation that demands a quick federal response, we have yet to find consensus on a particular approach. Regrettably, initial legislative efforts to address this problem were stymied by the perception of some that this was an insurance industry bailout.

Several weeks ago the Senate Banking Committee announced a framework for legislation that the Administration has broadly endorsed. Regrettably, no action has been taken on that proposal.

In the House, Financial Services Committee Chairman Oxley and Insurance Subcommittee Chairman Baker should be commended for securing House passage last week of a terrorism risk insurance bill. The Administration supported prompt passage of the House bill to move the process forward, though we continue to have reservations about the assessment mechanism and the bill's administrative complexity. At the same time, we applaud the House for including reasonable, short-term procedures for terrorist-related litigation. Procedures for consolidation and management of mass tort litigation arising out of a terrorism incident are a necessary part of any meaningful terrorism insurance proposal, and thus a necessary condition for Administration support of any terrorism insurance bill.

We are hopeful that the Senate will soon act and that the various approaches being discussed will be melded into a single consensus package in conference.

This must get done quickly. The majority of insurance contracts expire at year-end and renewal notices for next year are being prepared and sent to policyholders. Every day counts.

When I arrived at Treasury this past summer to assume the duties of the Assistant Secretary for Financial Institutions my portfolio included responsibility for a program known as critical infrastructure protection, or CIP for short. This program found its roots in a 1997 report of a presidential commission that had studied the potential vulnerabilities of major sectors, or infrastructures, to the threats of non-traditional warfare, that is, cyber and other terrorist threats. The commission identified energy, telecommunications, transportation, and banking and finance as "critical sectors," meaning that the full or partial failure of any of these could significantly degrade the nation's social and economic welfare. The commission recommended that government work with each of these sectors to bolster their defenses against cyber and other attacks, and under Presidential Decision Directive 63 (PDD 63) in May 1998, Treasury was directed to work with banking and finance.

Treasury and the industry initially focused on the cyber threat, as this appeared to be the newest and least understood threat to the banking and finance infrastructure, and it was the threat most emphasized by PDD 63.

With respect to cyber security, significant accomplishments have been made as a result of
PDD 63. Among others, notable achievements include:

• establishment of the Banking and Finance Sector Coordinating Committee in 1998 to supervise the industry's various responsibilities under PDD 63; and
• establishment of the financial services information sharing and analysis center (FS/ISAC) in 1999 to permit members to anonymously share information on cyber threats, vulnerabilities, incidents and solutions.

But we learned some important new lessons from September 11. Let me discuss our priorities as we see them now, and what it means for banking and finance going forward.

On balance, the financial sector responded remarkably well to the September 11 events. For the most part, major financial institutions successfully activated their business continuity plans, and banking and payment systems remained open for business. Also, financial institutions worked well with regulators to test and reopen debt and equity markets quickly.

A great deal of this success is attributable to the work done in preparation for Y2K as well as the subsequent emphasis on critical infrastructure protection under the mandate of PDD 63 and the business continuity/contingency plans required by regulators. Nonetheless past emphasis on cyber threats meant that while most institutions had established redundant systems, not all of them were geographically distant from the primary site. Establishment of geographically remote back up sites for institutions that represent concentrated financial activity has become a major issue. It also became clear that greater coordination between industry and all levels of government would be helpful.

Going forward, it appears that our earlier focus on cyber threats was too narrow, and that the CIP program will need to address the broad spectrum of physical and cyber threats.

High priority will be attached to developing a list of key points of contact among financial firms, government regulators and agencies (federal, state, local), industry utilities, and other providers (vendors) of critical services to banking and finance. Perhaps we need a secure, common call-in, or bridge number to facilitate communication among authorized parties. For its part, at the earliest possible date Treasury intends to establish and maintain a closed, secure communications network for itself and the primary federal regulators of financial institutions.

President Bush recently established a new Critical Infrastructure Protection Board comprised of senior executive branch representatives. The Board is to recommend policies and coordinate programs for protecting information systems for critical infrastructures, including emergency preparedness communications, and the physical assets that support such systems. This Board will have a standing committee on banking and finance that will be led by the Treasury Department.

This audience is no stranger to the issue of predatory lending nor the debates that have swirled in recent years on how to deal with this problem. Thus, I need not tell you what the problem is but rather will briefly highlight what I see as a promising approach for moving beyond debates and into action.

I believe that the Federal government should take a leadership role in encouraging private sector efforts to eliminate abusive lending practices, namely by encouraging the development of a set of industry best practices for subprime lending.

Many key players in the prime and subprime mortgage industry have already announced mortgage purchase guidelines. I understand that ACB has a task force underway to consider best practices or the development of guidance to avoid predatory lending practices. I look forward to meeting with your representatives in the very near future to discuss your ideas.

These are constructive efforts. I believe that an industry set of best practices makes appropriate use of market forces and still provides the Federal government with an enforcement role. For my part, I would like to explore whether the Treasury Department can play a leadership role in developing a set of national best practices for the subprime lending community. For regulated depository institutions, such practices could be incorporated into bank supervisory standards and enforced through the supervisory process. For lenders not subject to federal bank regulation, the FTC would have enforcement authority. If for example, the lender agreed to abide by a published set of industry best practices, but was later found not to have followed those practices, the FTC could bring an enforcement action based on unfair and deceptive practices.

The development of an industry set of best practices could help promote consistency and uniformity among state and local predatory lending laws. By setting national standards for good lending practices, a set of industry best practices might provide a good model for the efforts of state and local leaders in this area.

A code of best practices could also help consumers navigate the complex mortgage financing process by giving them some assurance that the lender with whom they are dealing adheres to certain core standards for which there are federal enforcement mechanisms.

It is in the interest of industry and consumer groups to work together in developing a set of industry best practices. In fact, many of the current subprime mortgage guidelines put in place by mortgage companies were developed in conjunction with consumer groups. By working together, I believe the Treasury Department, in partnership with lenders and consumer groups could strike an appropriate balance in terms of assuring widespread access to credit while protecting consumers from predatory practices. We must be aggressive and vigilant in our efforts to crack down on abuses. On the other hand, unnecessary or unduly cumbersome requirements on legitimate subprime lending will only cause mainstream lenders to withdraw from providing credit to those who need it most and are otherwise creditworthy.

These are challenging times, for our nation and for our financial system. I have touched on only three of the many challenges policymakers face today regarding financial institutions and housing. There are many others, such as deposit insurance reform, implementation of the Gramm-Leach-Bliley Act, regulatory coordination, money laundering, GSEs, privacy, and consumer protection.

These and other issues also warrant our attention. As we move ahead, I welcome an ongoing dialogue with you and your organization as we work together to build a strong, resilient financial system that will foster the economic growth and security of our great nation. Thank you.