InfoBytes Regulatory Restructuring Report, Issue Six, July 28, 2009
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Congress Examines Financial Regulatory Reform Proposals in Hearings; Treasury Submits Language for Various Components of the Reform Plan
House Financial Services Hears from Regulators on Financial Reform. On Friday, July 24, the House Financial Services Committee held a hearing that included the heads of Treasury, OCC, OTS, FDIC and the Fed to opine on the financial regulatory reform proposals being considered by Congress. This hearing comes on the heels of a number of additional hearings held during the past two weeks in Congress on financial regulatory reform, and the testimony by and questioning of the regulators focused on some of the most contentious aspects of the plan.
Treasury Secretary Timothy Geithner strongly defended the Administration’s plan, including the creation of an independent consumer financial protection agency (the “CFPA”) and the appointment of the Fed as the “systemic risk regulator.” He also spoke in support of the creation of the Financial Services Oversight Council, which would bring the heads of each major federal financial regulatory agency together to coordinate policy, resolve inter-agency disputes, and gather information to identify emerging risks. During questioning, several of the Republican members, including Reps. Garrett (R-NJ) and Hensarling (R-TX), again reiterated opposition to the CFPA, stating that the agency will essentially approve and deny consumer products, killing innovation. To counter this criticism, Rep. Watt (D-NC) sought assurance from Secretary Geithner that he would work with Congress to ensure that there would be no presumption of liability for a non-“plain vanilla” product. Many members also asked Mr. Geithner about the systemic risk Fannie Mae and Freddie Mac posed, and some questioned why those firms were not addressed in the Administration’s proposal. Both Chairman Frank and Secretary Geithner argued that Congress passed laws to address the GSEs in 2007 and 2008, and that is why they are not dealt with in this proposal. But, Secretary Geithner did agree that those firms got to a point where they posed systemic risk, and that this legislative reform effort must take lessons from the collapse of those entities.
The second panel included Fed Chairman Ben Bernanke, FDIC Chairwoman Sheila Bair, Comptroller of the Currency John Dugan, Acting Director of the OTS John Bowman, and Joseph Smith, North Carolina Commissioner of Banks (on behalf of the Conference of State Bank Supervisors). Chairman Bernanke testified primarily on the issue of the Fed acting as a systemic risk regulator and the ability to identify and address institutions that are “too big to fail.” Mr. Bernanke stressed that there are “important synergies between systemic risk regulation and monetary policy,” and that an expansion of the Fed’s power to act as systemic risk regulator would be an “incremental and natural extension” of its current role. Regarding the issue of the moral hazard of identifying firms as systemically important, Chairman Bernanke said that the creation of a mechanism for resolution of a systemically important nonbank financial firm, plus strengthened capital, liquidity and risk-management requirements should help counteract those moral hazard effects. He also generally supported the idea of an oversight council dedicated to monitoring the financial system as a whole. Finally, Mr. Bernanke stated that the creation of the CFPA, and the corresponding transfer of power away from the Fed, would result in the loss of significant expertise, including information gained in the role as prudential supervisor of the institutions.
Ms. Bair’s testimony touched on some of the same issues, and in particular she supported the creation of a new resolution regime for systemically important institutions, creation of the proposed oversight council, and also supported the CFPA. However, Ms. Bair urged that under any proposal the current functional regulators should retain the ability to examine institutions for both consumer protection and safety and soundness. Mr. Bowman also supported creation of one consumer protection regulator, with the caveat that functional regulators retain examination and enforcement powers to avoid separation of safety and soundness. In addition, Mr. Bowman urged uniform regulation of consumer protection products.
Similarly, Comptroller Dugan registered concern with the creation of the CFPA and the “related elimination of uniform national standards for national banks.” Mr. Dugan also generally supported granting the Fed power to act as systemic regulator, but did not support giving the Fed the power, as systemic regulator, to override the authority of the primary banking regulator. Like the other witnesses, Comptroller Dugan supported the creation of the oversight council.
Multiple Hearings Held to Examine Financial Regulatory Reform Proposals. Friday’s House Financial Services Committee hearing was the latest in a litany of hearings held by Congress over the previous two weeks examining individual aspects of the reform plan, such as creation of the Fed as the systemic risk regulator, to the full reform proposal generally. During these hearings, a few key issues continue to emerge as the focal points of discussion.
• Separating safety and soundness from consumer protection. The primary argument against creating the CFPA has been aversion to separating safety and soundness from consumer protection missions. Members, industry witnesses, and even the heads of the relevant banking agencies have all testified that separating the two missions could result in regulatory gaps, conflicting regulation, and greater costs to consumers. The opponents have pointed to the regulation of Fannie Mae and Freddie Mac as an example of the perils of separating the two missions, stating that the conflicting mandates of the HUD-driven affordable housing goals versus the OFHEO-run safety and soundness rules contributed heavily to the downfall of the GSEs. Proponents of the CFPA, including Chairman Barney Frank (D-MA), argue that consolidation of consumer protection functions is vital, and that it is clear that the current regulatory structure subjugates consumer protection to other responsibilities. Several consumer advocacy group witnesses, during a July 16th hearing, noted that the Federal Reserve Board in particular has failed to act on their existing authority to adopt strong consumer protection regulations. Treasury Assistant Secretary Michal Barr has testified twice in support of the CFPA and reiterated the Administration’s view that the current system is unacceptable for consumer protection.
• Power of the CFPA to regulate products. Another flashpoint in the debate on the creation of the CFPA revolves around the proposal to allow the agency to ban certain products and mandate that institutions offer so-called “plain vanilla” products the agency prescribes alongside other products. Opponents to this idea argue that such power will eventually stifle innovation and lead to fewer products and higher costs. Proponents say this will improve the understanding of consumers and allow for true comparison shopping, while eliminating the most harmful products from the marketplace.
• Uniformity of regulations/federal preemption. Proponents of uniform standards of regulation and federal preemption, including banking industry representatives and the heads of the OCC and OTS, argue that preemption is vital to provide clear and uniform standards and to avoid costly and confusing compliance with a patchwork of state laws.
• Granting the Fed additional powers. Many members of Congress have noted concern that the Fed did not act adequately to address the financial crises proactively, even though it had the ability to do so. Further, some members, including Senate Banking Committee Chairman Chris Dodd (D-CT) were critical of the Fed’s record in consumer protection, citing in particular the Fed’s delay in implementing additional mortgage regulations under the authority granted to it by the Home Ownership and Equity Protection Act (“HOEPA”). Consumer advocates in particular were critical of the Fed’s actions with regards to consumer protection laws during their testimony on July 16 in the House Financial Services Committee. However, representatives of the Fed have appeared before Congress several times in recent weeks to discuss their proposed role under the various aspects of the reform plan, not only for increased power to regulate systemic risk, but also to retain consumer protection powers. In a hearing on July 16, Federal Reserve Board member Elizabeth Duke argued that the Fed has the resources, structure and expertise to protect consumers and that replicating the expertise in a new agency would be “enormously challenging.” She also testified that consumer protection is complementary to prudential supervision, and, as such, the two should be regulated in concert. She also cited the recent rulemaking regulating consumer credit cards and the proposed rule on consumer mortgage products issued this week as examples proving that the Fed has the ability and expertise to fulfill the consumer protection regulator role. Chairman Bernanke repeated these views in the House Financial Services Committee hearing on July 24.
• Too Big to Fail. There has been significant debate, including entire hearings, devoted to the question of whether a systemic risk regulator (e.g., the Fed) should have the authority to label institutions as “systemically important” and therefore “too big to fail.” There was bipartisan concern in the House Financial Services Committee hearing on July 21st that by labeling an institution “systemically important” or “Tier 1”, the regulator would be institutionalizing “too big to fail,” and the government would be forced into more bailout situations. Chairman Barney Frank stated at the outset that the idea of a preexisting list of “too big to fail” firms is “pretty much gone” and that the government would have to operate on a “know it when we see it” standard.
To view the written testimony of the various hearings held in the House Financial Services Committee, please see http://financialservices.house.gov/hearings_all.shtml.
To view the written testimony of the Senate Banking Committee hearings related to regulatory reform, please see http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Home. The hearing on creation of the CFPA was on July 14, and the hearing regarding systemic risk regulation was on July 23.
Frank Delays Markup of Legislation. On Tuesday, July 21, House Financial Services Committee Chairman Barney Frank (D-MA) said he would postpone the planned markups on legislation to create the CFPA until after the August recess. In making the announcement, Chairman Frank reiterated his support for creation of the agency. There is one additional hearing scheduled in the Senate Banking Committee on the proposals to include a national insurance regulator. The House has no additional hearings scheduled prior to the August recess, but does plan to mark up financial institution compensation legislation next week.
Administration Sends Additional Legislative Language to Congress. Over the past two weeks, the Treasury Department has submitted to Congress legislative language addressing a number of components of the Administration’s financial regulatory reform plan. The legislation has been sent to Congress issue-by-issue, and divided into various titles of the full financial regulatory reform proposal. The various legislative proposals are the following (in chronological order as submitted to Congress):
• On July 15, Treasury sent to Congress legislative language that would require all hedge fund advisors and advisers of other private pools of capital, including private equity and venture capital funds, to register with the Securities and Exchange Commission. Among other things, as registrants, these entities would be subject to reporting and disclosure requirements, conflict-of-interest and anti-fraud restrictions, and examination and enforcement authority from the SEC. To view the Fact Sheet and proposed legislative language, please see http://www.treas.gov/press/releases/tg214.htm.
• On July 16, Treasury submitted legislative language, called “the Investor Protection Act of 2009,” to address compensation of executives of financial services companies. In particular, the legislation would ensure that compensation committees are independent, that compensation committees receive objective advice from legal counsel and consultants, and that compensation committees are able to hire independent consultants, attorneys and other advisors in setting and reviewing compensation packages. To view the Fact Sheet and proposed legislative language, please see http://www.treas.gov/press/releases/tg218.htm.
• On a related issue, Treasury submitted legislative language that would require all publicly traded companies to require shareholders to have a nonbinding vote on executive compensation packages (called “say-on-pay”). The legislation would also mandate a vote on golden parachute termination packages. For the Fact Sheet and proposed legislative language, please see http://www.treas.gov/press/releases/tg219.htm.
• On July 21, Treasury submitted language that would revamp the regulatory oversight of credit rating agencies. Among other things, it would restrict credit rating agencies from offering consulting services to companies that they rate, would strengthen disclosure of conflicts of interest, and require the disclosure of fees paid by the issuer for a particular rating. In addition, issuers would be required to disclose all preliminary ratings and include in their reports a clear description of data reliability, probability of default, and the sensitivity of a rating to changes in assumptions, among other things. Finally, the language would strengthen SEC supervision of rating agencies. To view the Fact Sheet and proposed language, please see http://www.treas.gov/press/releases/tg223.htm.
• On July 22, Treasury sent to Congress legislative language that would address systemic risk regulation. First, the legislation would create a Financial Services Oversight Council (“FSOC”) with responsibility to coordinate financial regulatory policy and resolve intra-agency disputes, as well as identify emerging risks to the financial system. The Council would consist of the heads of Treasury, the Fed, CFTC, FDIC, FHFA, SEC, and the directors of the proposed CFPA and the proposed National Bank Supervisor. Second, the legislation would subject all financial firms posing a threat to the financial stability of the country (i.e. “Tier 1 FHCs”) to consolidated supervision under the Fed, whether or not they own an insured depository institution, and would thus be subject to nonfinancial activities restrictions of the Bank Holding Company Act (“BHCA”). These Tier 1 FHCs would have higher prudential standards than other BHCs and would be subject to prompt corrective action in instances of capital level decline. In addition, among other things, the legislation would raise capital and management requirements for all FHCs, eliminate loopholes in the applicability of the BHCA by subjecting additional entities to regulation under the Act, and require all securitizers of asset-backed securities to retain 5% of the credit risk of underlying assets they securitize. To view the full legislative proposal, please see http://www.treas.gov/press/releases/tg227.htm.
• On July 23, Treasury submitted legislative language that would, among other things, create the new National Bank Supervisor by consolidating the OTS and the OCC. The consolidation would eliminate the federal thrift charter and thrift holding company framework. In addition, the legislation would reform the assessment of bank regulatory fees to require all banks over $10 billion in assets to pay examination fees, and lower the fees for other institutions such as community banks. Separately, the proposed legislation would create a regulatory regime to provide for orderly resolution of systemically important firms, based on the existing regime used for insured depository institutions under the Federal Deposit Insurance Act. Under this language, Treasury would appoint either the FDIC or the SEC as conservator or receiver with the power to take control of the operations of the firm or to sell or transfer the assets of the firm. To view the full text of the proposed legislation, please see http://www.treas.gov/press/releases/tg229.htm.