Yesterday, the House Committee on Financial Services held a hearing "to address the need for broad regulatory restructuring and reform for the financial markets, including financial institution oversight and regulation, systemic risk, and housing finance." This follows earlier hearings held by the committee on July 10 and July 24 at which representatives of Treasury, the Federal Reserve and the SEC testified, although the earlier hearings were dominated by discussions about the failure of Bear Stearns and concerns about the future of Fannie Mae and Freddie Mac. Testifying at yesterday's hearing were speakers from academia and various trade associations and the discussion focused on such issues as:

  • The current state of the U.S. and international financial regulatory systems, including the implications of current governmental lending and support facilities for the regulatory structure. 
  • Ways to measure and limit risk, improve market liquidity and restore confidence in financial markets and institutions through a stronger system of regulation and oversight. 
  • The need for enhanced capital and reserve requirements for financial institutions. 
  • The adequacy of current powers and coverage of the existing regulatory structure. 
  • Whether Congress needed to pass another stimulus package and, if so, whether the package should include new spending or tax cuts or both.

Appearing on the panel of economists and academics were:

  • Alice M. Rivlin, a Senior Fellow at the Brookings Institution and a former Federal Reserve Vice Chair 
  • Joseph E. Stiglitz, a Professor of Economics at Columbia University, former Chair of the Council of Economic Advisors and former Chief Economist at the World Bank 
  • Joel Seligman, President of the University of Rochester and well-known securities law expert 
  • Manual Johnson, co-chairman of Johnson Smick International and a former Federal Reserve Vice Chair

Appearing on the panel of trade association representatives were: 

  • Steve Bartlett, President of the Financial Services Roundtable 
  • Edward Yingling, President of the American Bankers Association 
  • Timothy Ryan, President of the Securities Industry and Financial Markets Association and former Director of the Office of Thrift Supervision 
  • Mike Washburn, representing the Independent Community Bankers of America

Because each Committee member was generally allowed to ask only one question, with little time for follow up or in-depth discussion, there was little detailed discussion of any particular proposed reform measure and little consensus reached. At times, the discussion was rather partisan, with Committee members from each party questioning decisions made by the other party and attributing failed past policies to their colleagues across the aisle.

Many Committee members and panelists generally agreed on a couple of overarching themes. First, what is needed is not more regulation or less regulation; but smarter regulation. Proposed regulatory reforms should allow for flexibility, since new products are developed all the time, and regulators need to be able to respond effectively to market changes. Second, a distinction must be drawn between immediate emergency measures to resolve the financial crisis and the comprehensive changes that may be required to fix the current regulatory framework. Overhaul of the regulatory system needs to be undertaken cautiously, with due consideration of the consequences.

Beyond these broad themes, a myriad of topics were raised, including: 

  • Regulation of credit default swaps (“CDS”) and other over-the-counter derivatives (“OTC derivatives”); 
  • The Gramm-Leach-Bliley Act; 
  • Opaque and misleading accounting practices, and possible accounting reforms; 
  • Credit rating agencies; 
  • Mortgage origination and securitization policies; 
  • Duplication and gaps within the federal regulatory system and both comprehensive and targeted regulatory reforms; and 
  • Fannie Mae and Freddie Mac.

The Committee seemed particularly interested in a few major areas, including regulation of the OTC derivatives market, fair and transparent accounting practices, and the practices of credit rating agencies. In addition, the Committee and panelists considered the idea that the current economic situation was primarily due to the failures of the unregulated and weakly regulated sectors of the financial services industry, rather than highly regulated banks. As such, panelists from the banking sector noted that any additional regulatory requirements should not dramatically increase the burdens on banks.

Proposals discussed briefly during the five-hour hearing included:

  • Instituting various corporate governance reforms; 
  • Providing a new $200-$300 billion stimulus package; 
  • Dividing some current large financial institutions into smaller, more manageable entities; 
  • Instituting additional clearing systems; 
  • Introducing new House and Senate Committees to address financial markets and regulation in a comprehensive way; 
  • Having volunteer credit rating agencies, so that these rating agencies may issue ratings on which investors can rely, if they choose; 
  • Having two classes of credit ratings: one for homogeneous products, and one for heterogeneous, riskier products; 
  • Requiring that credit rating agencies be paid by the investor rather than the issuer; 
  • Implementing limits on financial institution leverage; 
  • Reinstating the short-sale uptick rule, which was eliminated last year; 
  • Reducing mortgage interest rates; 
  • Having one regulatory body over the entire financial services regulatory system that would have access to information from all financial institutions, with a panoramic view of potential problems and trends; 
  • Combining the SEC and CFTC; 
  • Merging the Office of Thrift Supervision and the Office of the Comptroller of the Currency; and 
  • Providing community banks with additional capital to increase local and small business lending.

The Committee did not specify any next steps for considering legislation or regulation. However, yesterday’s discussion may lay the groundwork for future discussions and legislation addressing regulatory reforms. Professor Seligman urged each of the House and Senate to "create a Select Committee … to provide a focused and less contentious review of what should be done. The most difficult issues in discussing appropriate reform of our regulatory system become far more difficult when multiple Congressional committees with conflicting jurisdictions address overlapping issues." Committee Chairman Barney Frank echoed that sentiment in remarks made during a break in the hearing.