FROM THE OFFICE OF PUBLIC AFFAIRS

I am pleased to be invited to speak here today. This has been a very busy time for those of us working on financial services policy at Treasury. Our policy priorities have, not surprisingly, shifted significantly since September 11. My remarks will focus on those financial regulatory and legislative issues of interest to the securities bar that are currently on the front burner. I would also like to raise one other issue to which we hope to devote more attention in the months ahead.

I want to first summarize our regulatory implementation efforts on bank secrecy. As a result of the Patriot Act, which President Bush signed into law last month, there are more new grants of regulatory authority provided to the Secretary of the Treasury in this single piece of legislation than in the entire history of the Bank Secrecy Act since its enactment in 1972. This unprecedented level of authority is, of course, a direct consequence of the state of national emergency. Treasury intends to mandate the lowest possible level of burden to any regulation that is consistent with obtaining the highest possible level of benefit to those fighting terrorism and money laundering.

The statute requires that each financial institution have an anti-money laundering program. This should not impose significant new requirements on depository institutions, since they are already required to have in place anti-money laundering procedures and controls. The statute also authorizes rulemaking on the verification of customers when opening accounts. We recognize that depository institutions currently collect the Taxpayer Identification Number for most customers, and already generally examine government issued photo identification when establishing accounts.

The statute also extends suspicious activity reporting to securities brokerage firms, an effort that is well underway. In this way, there will be somewhat of a "level playing field" in requiring different types of financial services institutions at potential risk for money laundering abuse to be required to report similar types of critical information.

In implementing our responsibilities under the Patriot Act, Treasury will take a realistic look at costs as well as benefits, and will make the process as transparent as possible. We seek to minimize the regulatory burdens of new Bank Secrecy Act requirements while providing a real benefit to those working to achieve national security and law enforcement objectives.

Let me turn now to 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 that day 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 could be quite high indeed.

Without insurance, companies' credit position 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. But higher energy and transportation costs would drive up prices and reduce production across the board. Even with insurance, 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 settle upon should have a clear exit strategy for the government and should encourage the insurance industry to build capacity to insure terrorist acts as the government recedes from the market.

Over the past several weeks, we have been working with the Congress to find an agreeable solution. The good news is that we have achieved a broad, bipartisan consensus that this is a critical situation that demands a quick federal response. The bad news is that we have not yet reached consensus on a particular approach.

Even this bad news, however, is not bleak. The Senate Banking Committee has announced a framework for legislation that the Administration has broadly endorsed. And House Financial Services Chairman Oxley and Insurance Subcommittee Chairman Baker have introduced a bill that the Committee approved. We are hopeful that the various approaches being discussed will soon be melded into a single package that can garner broad congressional support and be quickly enacted. Yet 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. Thankfully, both congressional and Administration leaders understand this and are pressing forward to a solution.

We are also working to obtain Congressional passage this year of legislation to facilitate the termination and netting of financial contacts as proposed by the President's Working Group on Financial Markets. As you may know, Secretary O'Neill has written twice to Congress in recent weeks, once in a joint letter with Chairman Greenspan and another time jointly with all of the federal financial regulators, asking Congress to revise the bankruptcy and bank insolvency laws for this purpose.

The legislation would reduce uncertainty for financial market participants about the disposition of their contracts in the event that one of the counterparties becomes insolvent. This reduced uncertainty should limit market disruptions in the event of insolvency and mitigate risks to federally supervised market participants and to the financial system generally.

The relevant provisions are a non-controversial portion of broader legislation to revise the bankruptcy laws. We are concerned, however, that the controversial issues of the broader legislation may not be resolved soon enough to allow its passage this year. Whether as part of comprehensive bankruptcy reform legislation or as a stand-alone bill, we believe that Congress should enact netting legislation this year. Further delays would unnecessarily place the financial system at greater risk.

Another area in which we have been heavily immersed is critical infrastructure protection or CIP for short. This program has its roots in a 1997 report of a presidential commission that 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 several sectors, including 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 the government work with each of these sectors to bolster their defenses against cyber and other attacks, and 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. A Banking and Finance Sector Coordinating Committee was established in 1998 to supervise the industry's various CIP responsibilities. In 1999, the establishment of the financial services information sharing and analysis center (FS/ISAC) permitted members to anonymously share information on cyber threats, vulnerabilities, incidents and solutions.

But we learned some important new lessons from September 11. On balance, the financial sector responded remarkably well to the September 11 events. 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 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 their primary sites. Establishment of geographically remote back up sites for institutions which 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. Regulators seemed to be in contact with each other and with their respective regulated institutions, but there was no central, authoritative source of information on the system as a whole. Moreover, there wasn't a commonly held list of "key contacts" to call at major financial institutions, key trade associations and government agencies in order to exchange authoritative information.

Going forward, it is clear 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. Moreover, there is general agreement within the industry and among regulators that we need to develop a comprehensive crisis management capability.

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, which will be led by the Treasury Department. Until September 11, our CIP efforts were built on the twin pillars of private sector leadership and private sector innovation. Government's role had been principally to cajole and encourage and to rely on industry to do what is best and right to protect itself. Certainly, government will be more active in the future.

Finally, I would like to tee up an issue concerning the existing regulatory landscape. We are still learning the full implications for our existing regulatory structure of both the Gramm-Leach-Bliley Act and the ongoing evolution of our financial services system. In the months ahead, we expect to examine the merits and shortcomings of the current regulatory regime for the financial services system we hope to have in the years ahead.

A noteworthy development in banking regulation since the savings and loan crisis and commercial bank problems of the late 1980s has been the increased reliance on joint rulemaking among the federal banking agencies. Each of these agencies (along with state regulators) retains its own responsibilities for regulating, supervising, and examining different classes of depository institutions. But - prodded by Congress - the federal banking agencies have more closely coordinated rulemaking on capital requirements and other safety and soundness and consumer protection standards. This has promoted consistent rules for activities posing similar risks regardless of depository institution charter type.

Of course, competitiveness and conflict have not disappeared among the banking agencies. Only recently, banking regulators worked through disagreements about appropriate capital requirements for merchant banking and related private equity investments by banking organizations. Yet, in our view, this experience underscores the importance of encouraging interagency coordination.

The Gramm-Leach-Bliley (GLB) Act was a significant step in adapting U.S. banking law to the reality of financial services convergence in the marketplace. To accommodate a financial system where banking, securities, and insurance would be housed within the same organization, GLB endorsed the principle of functional regulation and refined the process for distinguishing among these products and activities. At the same time, GLB also recognized the importance of consolidated oversight for financial holding companies and preserved the role of the banking agencies as primary regulators of the banking units of these companies. Thus, GLB chose the path of incremental adaptation of our regulatory structure to accommodate an increasingly integrated financial services sector, rather than fundamental overhaul.

In the aftermath of GLB and as marketplace convergence of financial services continues, we need to turn our attention to extending rulemaking coordination efforts beyond the banking agencies to all federal and state financial regulators. I do not mean to suggest that the solution is a monolithic regulator for our entire system. We do not envision eliminating or altering the roles and responsibilities of existing financial regulators in enforcing regulations and supervising markets and institutions. But in order to ensure that financial activities posing like risks receive like regulatory treatment no matter where they are housed, we may need to improve how we coordinate financial regulation and resolve disputes that cross-regulatory jurisdictions. At a minimum, I believe we need an inter-agency mechanism to develop rules of cross-jurisdictional impact.

Regulatory reform is not a glamour issue. For as long as I can remember, people have complained about the U.S. system having too many regulators and too many over-lapping rules. Yet past proposals to come to grips with the problem have generally fallen flat, defeated by a combination of parochial interests -- in government and industry -- to maintain each individual regulator's turf, and the perception that this is a long term problem that could be put off for another day. Well, another day is now, and I would welcome the opportunity to have some serious discussions with you on how we can make the current system better. You are the ones that have to parse through our regulatory maze every time one of your clients wants to offer an innovative new product or service. You are the ones that have to help clients deal with multiple regulators and understand the myriad rules and compliance standards applicable to financial institutions offering multiple lines of services. So I would appreciate your coming to the table and talking with us about how we might further streamline the current system, without in any way compromising the efficiencies which derive from healthy regulatory competition.

Before concluding, let me briefly mention the problem of predatory lending. I recently spoke about the need to develop a nationwide set of best practices for the subprime lending community. That is a topic probably better suited for the banking bar than the securities bar, so I have not discussed it in detail today. I would note, however, that while your clients may not make subprime loans, many of them are involved in securitizing those loans and could, I believe, be an important partner in helping us reach the majority of subprime lenders with a new code of best practices. Toward that end, we have already discussed securities firm participation in this project with the Bond Market Association and look forward to working with its members as we develop and implement the Code.

That concludes my remarks. I would be happy to answer your questions.