December 11, 2007
HP-726
U.S. Treasury Assistant Secretary for Financial Institutions David G. Nason
Remarks before the City of London Corporation
Redesigning U.S. Financial Regulation for a Global Marketplace
London - Thank you very much. Michael, thank you for that kind introduction and to everyone gathered here today for welcoming me.
It is a privilege to be here today at the City of London in this beautiful and historic venue. The City of London has played a significant role in enhancing the position of London as a key center of financial and business activity. In late October in New York City, U.S. Treasury Secretary Henry M. Paulson, Jr. met with City of London officials, Policy and Resources Committee Chairman Michael Snyder, Assistant Director of Economic Development Paul Sizeland, and Director of Public Relations Tony Halmos, and New York City Mayor Michael Bloomberg to discuss the global competitiveness of the financial services industry.
I appreciate the City of London welcoming me here to continue this dialogue. I would like to begin today with a brief snapshot of current economic conditions and a short discussion of President Bush's recent announcement on housing issues. Finally, I will describe our current thinking about capital markets competitiveness as it relates to the Treasury Department's review of U.S. financial services regulation.
Economic Conditions
A common theme in my remarks today is that capital markets are no longer confined to geographical or national boundaries. Therefore, it makes sense to begin with a global economic view. From a global perspective, economic growth has been quite strong. The International Monetary Fund projects that by the end of this year, the world will have experienced five consecutive years in which real growth exceeded 4 percent. In fact, the average of those five years is almost 5 percent. This is the best five-year growth period in more than three decades. Not only is this growth widespread, but at the same time, world consumer price inflation is at its lowest level, averaging 3.6 percent during the past five years.
And although facing challenges, the U.S. economy remains fundamentally sound. Job creation is healthy with over 1.5 million new jobs being created in the past year, and the U.S. economy has now added jobs for 51 straight months. The unemployment rate is at 4.7 percent, close to its lowest reading in six years.
Real GDP growth in the United States was 4.9 percent in the third quarter of 2007, supported by strong gains in business investment and exports. Business spending on commercial structures and equipment rose solidly in the third quarter. Healthy corporate balance sheets bode well for continued investment growth. Strong global growth is boosting U.S. exports, which grew by 10.2 percent over the past four quarters. Importantly, core inflation remains contained, and the fiscal deficit has been reduced substantially.
However, the U.S. economy does face serious headwinds. A housing market correction, rooted in an eight-year period of exceptional housing price appreciation, remains the most serious risk to future economic growth. Other challenges include financial market dislocations and high energy prices. But our solid economic fundamentals coupled with the backdrop of the strong global economy should support continued economic growth in the United States.
Housing Markets and the Administration's Response
Regardless of any impact the housing correction will have on the economy, the Bush Administration recognizes the difficulty of this situation for the individual homeowners undergoing strain. Therefore I thought I would take a few moments to share our most current response to these issues.
Foreclosures are a fact of life, even in strong housing years. However, foreclosure starts have almost doubled in the last year and a half, and signs point to further increases. When rising at a rate outside of historical norms and concentrated in particular communities, foreclosures have a wider negative impact, driving down property values and undermining the financial stability of neighboring families. Therefore, we have worked through an evolving process to help minimize the impact of the housing downturn on homeowners, neighborhoods and the U.S. economy.
It is important to note at the outset the principles we use to approach this problem. Our efforts are targeted at homeowners who have demonstrated the financial ability to own a home over the long-term. Our efforts will not be designed to assist speculators who acquired real estate for investment purposes. We must endeavor to avoid bailing out lenders and investors, who should recognize the value of these impaired mortgages and should not expect government assistance in these commercial transactions. Lastly, the government should not subject lenders and investors to abrogation of bargained-for contractual rights.
Based on those core principles, we are implementing a three point plan. First, we are increasing efforts to reach able homeowners who are struggling with their mortgages. Second, we are working to increase the availability of affordable mortgage solutions for these borrowers. Third, we are leading the industry to develop systematic means of efficiently moving able homeowners with unaffordable subprime mortgages into sustainable mortgages.
The Administration called together a large group of mortgage servicers, counselors and investors, called the HOPE NOW alliance, to coordinate and improve efforts to reach more homeowners and find long-term solutions. The HOPE NOW alliance represents servicers who cover 84 percent of currently outstanding subprime mortgages. As Secretary Paulson said, the infrastructure to reach struggling borrowers is now in place: outreach letters have been sent to distressed borrowers, a toll-free number has been expanded and counselors are available to work with struggling borrowers.
The Administration has used existing authority to expand the Federal Housing Administration, a government-subsidized mortgage insurance program, to provide additional solutions. This expansion could help around 300,000 homeowners through 2008. However, we do need the U.S. Congress to pass widely supported bipartisan housing related legislation to expand the availability of affordable mortgage options for eligible distressed borrowers.
Last week, we announced the third part of the plan. The HOPE NOW alliance, which includes the American Securitization Forum, a group representing significant mortgage investors, announced a set of guidelines to streamline the process of refinancing and modifying subprime loans for able homeowners. The HOPE NOW alliance estimates up to 1.2 million subprime adjustable-rate mortgage (ARM) borrowers will be eligible for fast-tracking into affordable refinanced or modified mortgages under this streamlined approach. Servicers have committed to reporting progress in these efforts and we all look forward to transparent and monthly reports on the results of these efforts.
We anticipate that these guidelines will be adopted as reasonable and customary standard practice across the servicing industry. This is in everyone's interest – homeowner, servicer, and investor – to develop a market-based approach to avoid preventable foreclosures.
This plan will not prevent all foreclosures, nor should it. Some borrowers, particularly those who received loans under the most lax underwriting standards and who have not been able to make even their initial payments, likely will become renters again. The problems we are facing in the mortgage market are complex and unprecedented, and there is no perfect way to address them. This plan has evolved over time and will not be easy to implement. We continue to monitor the situation closely and work to address issues proactively as they arise.
The issues in the mortgage market highlight the challenges we as policymakers see with the constant evolution and innovations in our global capital markets. On the one hand, the complexity of the global and securitized mortgage market made it more difficult for the private sector to help homeowners modify their mortgages. On the other hand, this financial innovation increased access to credit and brought the dream of homeownership to a greater number of people than ever. Capable borrowers with less-than-perfect credit histories found opportunity through the ingenuity of our capital markets. So we must be careful that any response to this situation does not unnecessarily harm those borrowers or stifle beneficial financial innovation.
Financial Services Regulation
The recent stress in the financial markets demonstrates that economic systems can benefit from improved financial services regulation. Indeed, few regulated and non-regulated financial institutions have escaped the effects of market volatility over the past few months. It is in everyone's interest to have a more optimal framework for financial services regulation.
I would like to take a few minutes to underscore the importance of a competitive financial services industry. Over the past few decades the financial services industries in London and New York have contributed significantly to their countries' economic growth and prosperity. The financial services industry's contribution to the GDP in the United Kingdom has risen from 6.6 percent in 1996 to 9.4 percent in 2006 and in the U.S. from 6.8 percent in 1996 to 7.8 percent in 2006.
We, as policymakers, need to ensure that the financial services industry continues to contribute to this economic growth. And, one area where the United States must focus attention is the regulatory structure for the financial services industry. To that end, Secretary Paulson has asked the Treasury Department to undertake a comprehensive review of financial institutions regulation and to develop recommendations to modernize our regulatory system. We expect this review to be complete by early next year.
Examination and reexamination of financial services regulation are essential to fulfilling the Treasury Department's mission to promote the conditions for prosperity and stability in the United States and to encourage prosperity and stability in the rest of the world.
The globalization of the capital markets also prompts the need for analysis of the current regulatory structure in the United States. Companies now can raise capital across the world, seeking environments that provide adequate capital and liquidity at the best cost.
Initial public offerings (IPOs) data provide some of the more telling statistics of this new globalized environment. The number of global IPOs more than doubled from 839 in 2002 to 1729 in 2006, with 90 percent of the companies going public listing on their domestic exchanges. European exchanges raised the most capital, 39 percent (US$95 billion) of the total IPO capital raised in 2006, followed by Asia-Pacific exchanges with 35% (US$85.5 billion), and North American exchanges with 19 percent (US$46.3 billion).
Clearly, market participants today have many jurisdictional options for raising and investing capital. Because of this dynamic, market participants have choices today that were unavailable as recently as 10 years ago.
This borderless world pressures regulatory regimes to compete with each other because capital flows to where investors expect to achieve the greatest risk-adjusted return. However, a welcoming regulatory regime does not mean one that it is ineffective or lenient. In fact, market participants value well-regulated markets on account of their fostering market integrity and investor confidence.
Therefore, our working assumption is that in this new globalized marketplace, we are engaged in a race-to-the-top, to achieve the optimal regulatory structure for the financial services industry. The optimal regulatory structure needs to attract capital based on its effectiveness in promoting innovation, managing system-wide risks, and fostering consumer and investor confidence.
I believe that the race-to-the top is occurring at both a macro- and a micro-level. At the macro-level, we are witnessing the evolution and testing of various regulatory structures for the financial services sector.
For example, as you well know, the United Kingdom closely analyzed its regulatory structure just over a decade ago and made seminal changes such as separating bank supervision and monetary policy and consolidating financial services supervision under the umbrella of a single regulator. There are other macro-level models such as the "Twin Peaks" model adopted in Australia. This regulatory structure creates two distinct regulatory bodies – one responsible for prudential regulation of entities of such consequence that require prudential regulation and one responsible for market and disclosure regulation of financial products being offered to consumers and investors.
Quite different from these two relatively new approaches, the U.S. financial services regulatory structure has been largely knit together over the last 75 years. Much of this framework was put into place for particular reasons in a different time and in response to circumstances that no longer exist. We currently have five federal depository institution regulators, one federal securities regulator, one federal futures regulator and a state-based insurance regulatory system. We also have additional state based supervision of depositories and securities firms as well as self-regulatory organizations with broad regulatory powers. Our structure has evolved in order to meet the growing demands of our financial services industry, but this evolution has resulted largely in adding layers of regulation without an overall evaluation of the optimal way to regulate the financial services industry.
It is useful and productive to evaluate the strengths and weaknesses of these regulatory models. This testing and comparison will have the salutary effect of making each structure stronger.
[1] Ernst & Young, Globalization: Global IPO Trends Report 2007, 18, 20, 24.
[2]
In addition to macro-level regulatory competition issues, market and regulatory forces around the globe are also compelling dramatic changes at a more industry-specific level. Because we are in Europe, I thought it might be instructive to explore some European-led regulatory drivers that have had a significant impact in shaping U.S. regulatory policy. These issues are not new and are often discussed and debated between my colleagues at the Treasury Department and European officials in various regulatory dialogues.
One of the clearest examples of regulatory policies of non-U.S. jurisdictions shaping the regulatory landscape of U.S firms is the consolidated supervised entities (CSE) regime administered by the U.S. Securities and Exchange Commission (SEC). The creation of this regulatory regime was motivated largely by the requirements of the European Union's (E.U.) Financial Conglomerates Directive. This Directive requires non-E.U. financial institutions doing business in Europe to be supervised on a consolidated basis.
The CSE regime was created in 2004 and covers the largest investment banks that are not regulated by the Federal Reserve as bank holding companies. For the large investment banks that are part of the CSE regime, the SEC oversees not only the U.S.-registered broker-dealer, but also the consolidated entity, which may include other regulated entities such as foreign-registered broker-dealers and banks, as well as unregulated entities, such as derivatives dealers and the holding company itself. The CSE regime's mission is to diminish the likelihood that weakness in the holding company itself or any of its unregulated affiliates would place a regulated entity or the broader financial system at risk.
Insurance is another U.S. industry with a regulatory structure heavily influenced by external regulatory factors. In the U.S., insurance companies are regulated almost entirely by the states (unlike banks and other financial institutions that are regulated primarily at the federal level or on a dual federal/state basis). While the insurance regulatory structure debate dates back to a U.S. Supreme Court decision in 1869, Congress reaffirmed the decision to regulate insurance at the state level in the McCarran-Ferguson Act in 1945 and again in the Gramm-Leach-Bliley Act (GLBA) in 1999.
Under our current state-based regulatory system, each state has an insurance regulator charged with administering state insurance laws, promulgating regulations, and other duties pertaining to the supervision of the insurance business. The National Association of Insurance Commissioners (NAIC) is the primary vehicle through which state insurance regulators exchange information and coordinate activities to enhance the effectiveness of insurance regulation and attempt to bring about some degree of uniformity.
This structure raises a number of issues with an international dimension. Our regulatory structure raises questions of comity because foreign firms find adapting to over 50 differing state standards more difficult. This can limit international firms' operations in the United States, ultimately hurting U.S. consumers. Similarly, because of our structure, foreign officials and insurance companies have no single federal regulator with whom to coordinate on insurance matters.
Of course, the U.S. insurance market and the global nature of insurance are vastly different than they were six decades ago when McCarran-Ferguson was enacted and even from the almost 10 years since GLBA. Non-U.S. regulatory authorities are reevaluating the insurance regulatory regime reflecting the changes taking place in the insurance markets.
The European Commission's proposed new Solvency II legislation, coupled with the Reinsurance Directive, represents a major effort to reorient and modernize insurance regulation, treating insurance firms as cross-border actors.
Not surprisingly, these decisions are impacting how we in the United States view our insurance regulatory structure. The NAIC is currently considering updates to the U.S. risk-based capital and reinsurance policies. As we evaluate proposals to modernize our own system of insurance regulation, we must consider what will best serve our interests and the global economy in maintaining an insurance marketplace that attracts capital and does not set up artificial and costly barriers.
There are other examples than those that I mention here, and there are numerous circumstances in which the U.S. regulatory approach has shaped other countries' approaches. Therefore, it seems clear that now more than ever significant external regulatory competitive pressures require a constant reevaluation of financial services regulatory structure.
The Blueprint for Reform
Thus, I hope I have described adequately some of the motivating forces for the Treasury Department's undertaking to craft a blueprint for an improved U.S. financial regulatory structure. Let me share our approach to this project and what we hope to achieve. Our overarching goal is to craft recommendations that will result in a regulatory regime that most efficiently:
- safeguards the safety and stability of the financial system;
- maintains high standards of both consumer and investor protection; and
- promotes efficient and competitive capital markets.
As part of this effort and in order to inform our work, the Treasury Department published a Federal Register notice seeking public comment on a series of questions about regulatory structure and received more than 350 comment letters in response. This level of participation in the Department's study highlights the importance and complexity of our task.
As we analyze these comment letters, we are forming the framework of our recommendations which will fall into two main categories.
First, in keeping with the theme I described earlier, we will propose some broad ideas for an optimal regulatory structure to match the globally-integrated U.S. financial services industry. You should not be surprised to hear that this optimal structure will not match our current structure exactly. This will be a newly-designed model for the U.S financial services industry that should meet the needs of today and be flexible enough to address the issues that might come tomorrow. It will recognize the global nature of our capital markets, the greatly increased complexity of financial products, the importance of technology to the financial services sector, and the importance of consumer and investor protection in the provision of financial products.
Of course, we recognize that there are many difficulties in obtaining wholesale changes to regulatory structure. There are many political and parochial concerns and some are hesitant and generally opposed to change. We recognize this fact. Therefore, our second category will consist of less conceptual recommendations that we believe will serve as intermediate steps to put us on the path towards the optimal structure of financial services regulation.
Success of this initiative will not and should not be tied to short-term accomplishments. Today, I have identified the issues and segments where we will focus during this project. Some of the recommendations will be immediately relevant to legislative and regulatory policy issues. On these matters, our hope is that the Treasury Department's report will spur near-term tangible results. Implementation of other, longer-term recommendations will be subject to outside factors but will be ready should support for these reforms develop. Finally, our hope is that some of the recommendations will shape future debates regarding regulatory structure issues.
[3] John D. Hawke, Jr. "Viewpoint: The Roadblocks for Regulatory Revamp." American Banker 26 Oct. (2007) (noting the difficulties of wholesale changes but the importance of undertaking this type of evaluation).
Thank you for your time and your hospitality. It is truly a privilege to be here and I am happy to continue this dialogue if you have any questions.