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Jan 2009 GAO report on the financial regulatory system

Jan 2009 GAO report on the financial regulatory system

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Published by Christopher Dorobek
January 2009 report by the Government Accountability Office on the regulatory system titled "Financial Regulation: A Framework for Crafting and Assessing Proposals to modernize the outdated U.S. financial regulatory system"
January 2009 report by the Government Accountability Office on the regulatory system titled "Financial Regulation: A Framework for Crafting and Assessing Proposals to modernize the outdated U.S. financial regulatory system"

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Published by: Christopher Dorobek on Jan 09, 2009
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10/16/2011

 
 
Report toCongressional Addressees
United States Government Accountability Office
GAOFINANCIALREGULATION A Framework forCrafting and AssessingProposals toModernize theOutdated U.S.Financial RegulatorySystem
January 2009GAO-09-216
 
What GAO Found
United States Government Accountability Office
Why GAO Did This Study
H
ighlights
Accountability Integrity Reliability
 
January 2009
 
FINANCIAL REGULATION
A Framework for Craftin
g
and A
ss
e
ss
in
g
Propo
s
al
s
 to Modernize the Outdated U.
S
. Financial Re
g
ulatory
S
y
s
tem
Highlights ofGAO-09-216, a report tocongressional addressees
The United States and othercountries are in the midst of theworst financial crisis in more than75 years. While much of theattention of policymakersunderstandably has been focusedon taking short-term steps toaddress the immediate nature of the crisis, these events have servedto strikingly demonstrate that thecurrent U.S. financial regulatorysystem is in need of significantreform.To help policymakers betterunderstand existing problems withthe financial regulatory system andcraft and evaluate reform proposals, this report (1) describesthe origins of the current financialregulatory system, (2) describes various market developments andchanges that have createdchallenges for the current system,and (3) presents an evaluationframework that can be used byCongress and others to shape potential regulatory reform efforts.To do this work, GAO synthesizedexisting GAO work and otherstudies and met with dozens of representatives of financialregulatory agencies, industryassociations, consumer advocacyorganizations, and others.Twenty-nine regulators, industryassociations, and consumer groupsalso reviewed a draft of this reportand provided valuable input thatwas incorporated as appropriate.In general, reviewers commentedthat the report represented animportant and thorough review of the issues related to regulatoryreform.
The current U.S. financial regulatory system has relied on a fragmented andcomplex arrangement of federal and state regulators—put into place over the past 150 years—that has not kept pace with major developments in financialmarkets and products in recent decades. As the nation finds itself in the midstof one of the worst financial crises ever, the regulatory system increasinglyappears to be ill-suited to meet the nation’s needs in the 21st century. Today,responsibilities for overseeing the financial services industry are sharedamong almost a dozen federal banking, securities, futures, and otherregulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies. Much of this structure has developed asthe result of statutory and regulatory changes that were often implemented inresponse to financial crises or significant developments in the financialservices sector. For example, the Federal Reserve System was created in 1913in response to financial panics and instability around the turn of the century,and much of the remaining structure for bank and securities regulation wascreated as the result of the Great Depression turmoil of the 1920s and 1930s.Several key changes in financial markets and products in recent decades havehighlighted significant limitations and gaps in the existing regulatory system.
 
First, regulators have struggled, and often failed, to mitigate thesystemic risks posed by large and interconnected financialconglomerates and to ensure they adequately manage their risks. The portion of firms operating as conglomerates that cross financialsectors of banking, securities, and insurance increased significantly inrecent years, but none of the regulators is tasked with assessing therisks posed across the entire financial system.
 
Second, regulators have had to address problems in financial marketsresulting from the activities of large and sometimes less-regulatedmarket participants—such as nonbank mortgage lenders, hedge funds,and credit rating agencies—some of which play significant roles intoday’s financial markets.
 
Third, the increasing prevalence of new and more complex investment products has challenged regulators and investors, and consumershave faced difficulty understanding new and increasingly complexretail mortgage and credit products. Regulators failed to adequatelyoversee the sale of mortgage products that posed risks to consumersand the stability of the financial system.
 
Fourth, standard setters for accounting and financial regulators havefaced growing challenges in ensuring that accounting and auditstandards appropriately respond to financial market developments,and in addressing challenges arising from the global convergence of accounting and auditing standards.
 
Finally, despite the increasingly global aspects of financial markets,the current fragmented U.S. regulatory structure has complicatedsome efforts to coordinate internationally with other regulators.
To view the full product, including the scopeand methodology, click onGAO-09-216.For more information, contact Orice M.Williams at (202) 512-8678 orwilliamso@gao.gov.
 
United States Government Accountability Office
 
Hi
g
hli
g
ht
s
of GAO-09-216 (continued)
 As a result of significant market developments in recentdecades that have outpaced a fragmented and outdatedregulatory structure, significant reforms to the U.S.regulatory system are critically and urgently needed. Thecurrent system has important weaknesses that, if notaddressed, will continue to expose the nation’s financialsystem to serious risks. As early as 1994, GAO identifiedthe need to examine the federal financial regulatorystructure, including the need to address the risks fromnew unregulated products. Since then, GAO hasdescribed various options for Congress to consider, eachof which provides potential improvements, as well assome risks and potential costs. This report offers aframework for crafting and evaluating regulatory reform proposals; it consists of the following ninecharacteristics that should be reflected in any newregulatory system. By applying the elements of thisframework, the relative strengths and weaknesses of anyreform proposal should be better revealed, and policymakers should be able to focus on identifyingtrade-offs and balancing competing goals. Similarly, theframework could be used to craft proposals, or toidentify aspects to be added to existing proposals tomake them more effective and appropriate foraddressing the limitations of the current system.
Characteri
s
tic De
s
cription
 
Clearly definedre
g
ulatory
g
oal
s
 
Goals should be clearly articulated and relevant, so that regulators can effectively carry out theirmissions and be held accountable. Key issues include considering the benefits of re-examining thegoals of financial regulation to gain needed consensus and making explicit a set of updatedcomprehensive and cohesive goals that reflect today’s environment.
 
Appropriatelycomprehen
s
ive
Financial regulations should cover all activities that pose risks or are otherwise important to meetingregulatory goals and should ensure that appropriate determinations are made about how extensivesuch regulations should be, considering that some activities may require less regulation than others.Key issues include identifying risk-based criteria, such as a product’s or institution’s potential tocreate systemic problems, for determining the appropriate level of oversight for financial activities andinstitutions, including closing gaps that contributed to the current crisis.
 
S
y
s
temwide focu
s
 
Mechanisms should be included for identifying, monitoring, and managing risks to the financialsystem regardless of the source of the risk. Given that no regulator is currently tasked with this, keyissues include determining how to effectively monitor market developments to identify potential risks;the degree, if any, to which regulatory intervention might be required; and who should hold suchresponsibilities.
 
Flexible andadaptable
A regulatory system that is flexible and forward looking allows regulators to readily adapt to marketinnovations and changes. Key issues include identifying and acting on emerging risks in a timely waywithout hindering innovation.
 
Efficient andeffective
Effective and efficient oversight should be developed, including eliminating overlapping federalregulatory missions where appropriate, and minimizing regulatory burden without sacrificing effectiveoversight. Any changes to the system should be continually focused on improving the effectivenessof the financial regulatory system. Key issues include determining opportunities for consolidationgiven the large number of overlapping participants now, identifying the appropriate role of states andself-regulation, and ensuring a smooth transition to any new system.
 
Con
s
i
s
tent con
s
umerand inve
s
torprotection
Consumer and investor protection should be included as part of the regulatory mission to ensure thatmarket participants receive consistent, useful information, as well as legal protections for similarfinancial products and services, including disclosures, sales practice standards, and suitabilityrequirements. Key issues include determining what amount, if any, of consolidation
 
of responsibilitymay be necessary to streamline consumer protection activities across the financial services industry.
 
Re
g
ulator
s
providedwith independence,prominence,authority, andaccountability
Regulators should have independence from inappropriate influence, as well as prominence andauthority to carry out and enforce statutory missions, and be clearly accountable for meetingregulatory goals. With regulators with varying levels of prominence and funding schemes now, keyissues include how to appropriately structure and fund agencies to ensure that each one’s structuresufficiently achieves these characteristics.
 
Con
s
i
s
tent financialover
s
i
g
ht
Similar institutions, products, risks, and services should be subject to consistent regulation, oversight,and transparency, which should help minimize negative competitive outcomes while harmonizingoversight, both within the United States and internationally. Key issues include identifying activitiesthat pose similar risks, and streamlining regulatory activities to achieve consistency.
 
Minimal taxpayerexpo
s
ure
A regulatory system should foster financial markets that are resilient enough to absorb failures andthereby limit the need for federal intervention and limit taxpayers’ exposure to financial risk. Keyissues include identifying safeguards to prevent systemic crises and minimizing moral hazard.
Source: GAO.

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