Wednesday, the Senate Committee on Banking, Housing and Urban Affairs held a hearing to assess ideas to modernize the U.S. financial regulatory system. Witness testimony was presented by the following individuals:

Paul A. Volcker, Chair of the President’s Economic Recovery Advisory Board and Former Chairman, Board of Governors of the Federal Reserve System

Gene L. Dodaro, Acting Comptroller General, United States Government Accountability Office

The hearing opened with remarks from Chairman Christopher Dodd (D-CT) on the Committee’s approach toward considering alternatives for restructuring the financial regulatory system. Specifically, he focused on goals of increasing consumer protection and regulation of systemic risks, as well as the knowledge base and independence of regulators. He also stated that, with limited time, the Committee “must move forcefully and aggressively to protect consumers, investors and others within a revamped regulatory system.” Ranking Member Richard Shelby (R-AL) followed with opening remarks suggesting more of a “wait and see” approach – indicating that significantly more information should be gathered by the Committee before any action should be taken or recommended. He noted that history provides examples of analytic processes that should be followed, and specifically noted the Committee’s actions during the 1930s to review and investigate stock market abuses as an example of how to proceed during the current crisis.

After opening remarks, Chairman Volcker delivered his prepared statement, summarizing the recently issued report from “Group of 30” – an international group of individuals from the public and private sectors with extensive financial experience. Chairman Volcker explained that the report noted the continuing consolidation of banking enterprises and concentration of banking services in a few “systemically important institutions.” He noted that failure of any of these institutions would have widespread economic repercussions, and argued that additional scrutiny and regulation of institutions identified as systemically important would be required. He also advised against non-financial institutions owning any or part of government-insured deposit institutions, and argued against the dual public/private missions of the GSEs noting that, in times of crisis, they had failed to satisfy either mission.

Chairman Volcker then fielded questions about a variety of topics, including the merits of broadening the Federal Reserve’s regulatory scope, regulating complicated financial instruments for systemic risk, and the increasing consolidation of the U.S. banking industry, posing the question of whether certain systemic institutions are even “too big to exist.” Chairman Volcker advocated a global, unified accounting system, and also emphasized that limiting regulation to avoid losing commerce to foreign markets would be imprudent, noting that “good regulation” would serve a greater long-term benefit to the U.S. markets. Chairman Volcker also indicated that some (but not complete) consolidation of the banking regulatory authorities in the U.S. would be beneficial.

Chairman Volcker’s testimony was followed by prepared testimony from Mr. Dodaro (accompanied by GAO staffers Mr. Rick Hillman and Ms. Orice Williams) regarding the GAO’s report “A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System.” Specifically, he noted that the current system is “outdated, fragmented and ill-suited to meet the 21st century needs” of the U.S.

Mr. Dodaro identified three main areas of focus for regulatory reform. First, he argued that the regulators have struggled and often failed to mitigate system risk of large financial institutions or ensure that they have managed their own risk. Second, he argued that regulators have been confronted with large market participants that are less regulated, such as non-bank mortgage lenders. Third, the industry has been challenged by new and complicated financial instruments, such as CDOs, credit default swaps and other instruments that have outpaced the ability of regulators to follow. To address these focus areas, Mr. Dodaro outlined the following nine “touchstones” to help address the failures of the current system:

  • Regulatory goals need to be clear and should drive the substance of the reform.
  • Regulatory reform measures should be articulated in statute to ensure consistency.
  • Reform needs to be comprehensive.
  • System-wide risk should be addressed.
  • A regime should be flexible and adaptable, allowing for innovation while maintaining a sense of associated risks.
  • The regulatory system should be efficient and effective. Overlapping regulatory jurisdictions should be consolidated.
  • Consumer protection should be of paramount importance. An emphasis should be placed on financial literacy.
  • Regulators must have the proper authorities and independence, including from funding sources.
  • Taxpayer exposure should be minimized.

Following his opening statement, Mr. Dodaro, Mr. Hillman and Ms. Williams responded to questions from the Committee, addressing such topics as the consolidation of banking and financial instrument regulatory authorities, the creation of a federal insurance regulator and the benefits and detriments of state-chartered versus federally chartered organizations. Mr. Dodaro emphasized the importance of having a “systemic risk” regulator. In addition, Mr. Dodaro and his staff noted the importance of enforcing corporate governance in the context of new regulation, and argued for placing emphasis on the nature of risk, rather than the type of product or institution, in determining the scope of regulation.