After 75 years of a “largely knit together” regulatory structure, the Treasury Department unveiled its Blueprint for a Modernized Financial Regulatory Structure on March 31, 2008. The Treasury Department issued the Blueprint as a result of a March 2007, conference on capital market competitiveness in which current and former policymakers, as well as industry leaders, noted that, while functioning well, the U.S. regulatory structure was not optimal for promoting a competitive financial services sector.
The Blueprint presents a series of “short-term” and “intermediate-term” recommendations that could immediately improve the U.S. regulatory structure. The Blueprint also presents a conceptual model for an optimal regulatory framework.
In his remarks announcing the Blueprint, Treasury Secretary Henry M. Paulson Jr. noted that:
This is a complex subject deserving serious attention. Those who want to quickly label the Blueprint as advocating “more” or “less” regulation are over-simplifying this critical and inevitable debate. The Blueprint is about structure and responsibilities – not the regulations each entity would write. The benefit of the structure we outline is the accountability that stems from having one agency responsible for each regulatory objective. Few, if any, will defend our current balkanized system as optimal.
In developing the recommendations in the Blueprint, the Treasury Department noted that “each and every recommendation” was developed “in the spirit of promoting market stability and consumer protection.”
Short-Term Recommendations
The Blueprint’s short-term recommendations are designed to be implemented immediately in the wake of recent events in the credit and mortgage markets and are intended to strengthen and enhance market stability and business conduct regulation. These short-term recommendations would be a transition to the intermediate-term recommendations and the proposed optimal regulatory structure model.
Enhancing the President’s Working Group on Financial Markets
The President’s Working Group on Financial Markets (PWG) was created by Executive Order 12631 in the aftermath of the 1987 stock market decline and acts as an inter-agency coordinator for financial market regulation and policy issues.
The Blueprint recommends that the Executive Order be amended to enhance the PWG’s effectiveness. The changes that are recommended include: broadening the PWG’s focus to include the entire financial sector rather than just the financial markets; having better interagency coordination and communication; and expanding the PWG’s membership to include the heads of the Office of the Comptroller of the Currency, Federal Deposit Insurance Corp. and Office of Thrift Supervision.
Mortgage Originations
Attributing the high level of delinquencies, defaults and foreclosures among subprime borrowers in 2007 and 2008 to gaps in the U.S. oversight system for mortgage originations, the Blueprint seeks to address these gaps in three ways. First, the Mortgage Origination Commission (MOC) should be established and be responsible for developing minimum licensing qualification standards for state mortgage market participants. The Blueprint also recommends that the Federal Reserve Board should retain its authority to draft regulations for national mortgage lending laws. Finally, the Blueprint provides that enforcement authority for federal laws should be clarified and enhanced.
Discount Window Lending
The Fed’s extraordinary move, in March 2008, to allow non-depository institutions to use its discount lending window to provide liquidity to the credit markets reflected the fundamentally different nature of the Fed’s market stability function in today’s financial market compared to those of the past. Given the increased importance of non-depository institutions to overall market stability, the Blueprint recommends the consideration of two issues. First, the availability of the discount window to non-depository institutions to provide temporary liquidity during those rare circumstances when market stability is threatened should be enhanced. Among the enhancements mentioned are: transparency; appropriate lending conditions; and adequate information provided to the Fed. The second recommendation is that the PWG should consider broader regulatory issues associated with providing discount window access to non-depository institutions.
Intermediate-Term Recommendations
Intermediate-term recommendations are designed to increase the efficiency of financial regulation. The Blueprint notes that some of these recommendations can be accomplished relatively soon, but “consensus on others will be difficult to obtain in the near term.”
Federal Thrift Charters
Deeming the thrift charter no longer necessary to ensure sufficient residential mortgage loans are made available to U.S. consumers, the Blueprint calls for phasing out and transitioning the federal thrift charter to the national bank charter. The Blueprint provides that the transition should take place over a two-year period.
Federal Supervision of State-Chartered Banks
The current regulatory structure whereby a state-chartered bank’s primary federal regulator is dependent upon whether the bank is a member of the Federal Reserve System needs to be “rationalized” according the Blueprint’s recommendations. Either all state-chartered banks are to be subject to supervision only by the Fed or only by the FDIC. The Blueprint calls for a study that examines the evolving role of the Federal Reserve Banks so as to make a definitive proposal regarding the appropriate federal supervisor for state-chartered banks.
Insurance
Although the business of insurance has had little direct federal involvement for over 135 years, the Blueprint notes that changes in the insurance marketplace, to a global marketplace, have increasingly put strains on the state-based regulatory system. For example, insurers operating on a national basis are subject to different laws and regulatory regimes in each state in which they conduct business.
To address the strains a state-based regulatory structure has created, the Blueprint recommends the creation of an optional federal charter (OFC). State-based regulation would still be available for those insurers not choosing to operate at the national level.
An insurer opting for an OFC would be limited to providing either life insurance or property and casualty insurance, the insurer would not be able to offer both lines of insurance. However, a life insurer would be able also to offer annuities, and other products, such as disability income insurance and long-term care insurance. Likewise, a property and casualty insurer would be able to offer liability insurance, car insurance and other specified lines of business.
To regulate an OFC, the Blueprint recommends the establishment of the Office of National Insurance (ONI) which would be part of the Treasury Department.
The Blueprint recognizes that while an OFC offers the best opportunity to develop a modern and comprehensive system of insurance regulation, the debate in Congress on this regulatory structure will be difficult and ongoing. In addition, the Treasury Department recognizes that some aspects of the insurance industry and its regulatory regime require immediate attention. Therefore, the Blueprint recommends that Congress create an Office of Insurance Oversight (OIO) within the Treasury Department to focus on key areas of federal interest in the insurance industry. Specifically, the OIO would address international regulatory issues and be the lead regulatory voice in the promotion of international insurance regulatory policy for the United States.
Futures and Securities
The Blueprint calls the regulatory bifurcation of the futures and securities markets “untenable, potentially harmful, and inefficient” given product and market participant convergence, market linkages and globalization. Therefore, the Blueprint recommends that the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) be merged to provide unified oversight and regulation. To accomplish the merger, the Blueprint recommends that the SEC take a number of steps to modernize the SEC’s regulations prior to the merger. The Blueprint also calls for any legislation merging the CFTC and SEC to provide for a process to merge regulatory philosophies and to harmonize securities and futures regulations and statutes.
Optimal Regulatory Structure
The last component of the Blueprint is the creation of an optimal regulatory structure for financial institution. The Blueprint notes that there are four possible options. The first option is to retain the current functional regulation regime, set up by the Gramm-Leach-Bliley Act, in which regulation is divided by historical industry segments of banking, insurance, securities and futures. The second option is to move to a more functional-based system of regulating the activities of financial services firms as opposed to industry segments. The third option is to move to a single regulator for all financial services as adopted in the United Kingdom. The final option is to adopt the ‘Twin Peaks” model that is used in Australia and the Netherlands. This model emphasizes regulation by objective: One financial regulatory agency is responsible for prudential regulation of relevant financial institutions, and a separate and distinct regulatory agency is responsible for business conduct and consumer protection issues.
Of all the options, the Treasury Department believes that an objectives-based regulatory approach would represent the optimal regulatory structure for the future and would focus on three key goals: market stability regulation, prudential financial regulation and business conduct regulation. Each of these goals would be overseen by three distinct regulators: market stability regulator, Prudential Financial Regulatory Agency (PFRA) and Conduct of Business Regulatory Agency (CBRA). In addition, the Blueprint would provide for two other regulatory authorities: a federal insurance guarantor and a corporate finance regulator.
To further accomplish optimal structure, the Blueprint calls for the establishment of three separate federal charters for financial services providers. There would be a federal insured depository institution (FIDI) charter for all depository institutions with federal deposit insurance; a federal insurance institution (FII) charter for insurers offering retail products where some type of government guarantee is present; and a federal financial services provider (FFSP) charter for all other types of financial services providers.
Market Stability Regulator
The Blueprint provides that the Fed should assume the role of market stability regulator given the agency’s traditional central bank role of promoting overall macroeconomic stability. This new role would replace its traditional role as a supervisor of certain banks and all bank holding companies.
To carry out its role as market stability regulator, the Fed should have the responsibility and authority to gather appropriate information, disclose information, collaborate with the other regulators on rulemaking, and take corrective actions when necessary in the interest of overall financial market stability.
The Blueprint also provides that the Fed should continue to be the “lender of last resort” by providing credit through its discount window. The Blueprint does note, however, that there should be a distinction between “normal” discount lending and “market stability” discount window lending and that a sufficiently high threshold should be established for market stability discount window lending.
Prudential Financial Regulator
A prudential financial regulator (PFRA) would focus on financial institutions with some type of explicit government guarantees associated with their business operations, such as federally-insured depository institutions, and would assume the roles of current federal prudential regulators, such as the OCC and the OTS. Prudential regulation would operate like the current regulation of insured depository institutions, with capital adequacy requirements, investment limits, activity limits, and direct on-site risk management supervision.
Business Conduct Regulator
The overall goal of the business conduct regulator (CBRA) is to provide appropriate standards for firms to be able to enter the financial services industry and sell their products and services to customers. The CBRA would monitor business conduct regulation across all types of financial firms, including FIIs, FIDIs, and FFSPs and focus on consumer protection such as disclosures, business practices, and chartering and licensing of certain types of financial firms.
Given the breadth and scope of the CBRA’s responsibilities, some aspect of self regulation should form an important component of implementation. The Blueprint notes that the self regulatory organization (SRO) model used in the securities and futures industries should be preserved. That model could be considered for other areas, or the structure could allow for certain modifications, such as maintaining rulemaking authority with CRBA, while relying on an SRO model for compliance and enforcement.
Federal Insurance Guarantee Corporation
The Blueprint would reconstitute the FDIC as the Federal Insurance Guarantee Corporation (FIGC) to act as an insurer and the FIGC would have the authority to set risk-based premiums, charge expost assessments, act as a receiver for failed FIDIs or FIIs, and maintain some back-up examination authority over those institutions. The FIGC will not possess any additional direct regulatory authority.
Corporate Finance Regulator
Finally, the Blueprint provides that the corporate finance regulator should have responsibility for general issues related to corporate oversight in public securities markets. These responsibilities should include the SEC’s current responsibilities over corporate disclosures, corporate governance, accounting oversight, and other similar issues. As discussed above, CBRA would assume the SEC’s current business conduct regulatory and enforcement authority over financial institutions.
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