Statements on Introduced Bills and Joint Resolutions

Floor Speech

STATEMENTS ON INTRODUCED BILLS AND JOINT RESOLUTIONS -- (Senate - March 23, 2009)

By Ms. COLLINS:

S. 664. A bill to create a systemic risk monitor for the financial system of the United States, to oversee financial regulatory activities of the Federal Government, and for other purposes; to the Committee on Banking, Housing, and Urban Affairs.

Ms. COLLINS. Mr. President, at the heart of the deep recession is a crisis in our financial system that has choked off credit upon which the health of our economy depends. With their jobs disappearing and their life savings evaporating, the American people rightly ask why the Federal Government failed to protect them from Wall Street's greed, unwise decisions, and manipulations that have caused so much harm.

As a former Maine financial regulator, I am convinced regulatory reform is essential to restoring public confidence in our financial markets. America's main street small businesses, homeowners, employees, savers, and investors deserve the protection of a new regulatory system that modernizes regulatory agencies, sets safety and soundness requirements for financial institutions to prevent excessive risk-taking, and improves oversight, accountability, and transparency.

To achieve those goals, I am introducing the Financial System Stabilization and Reform Act of 2009. This legislation will fundamentally restructure our financial regulatory system. It will strengthen oversight and accountability in our financial markets, and it would help rebuild the confidence of our citizens in our economy and help restore stability to our financial markets.

Mr. President, as financial institutions speculated in increasingly risky products and practices, not one of the hundreds of Federal and State agencies involved in financial regulation was responsible for detecting and assessing the risk to the system as a whole. The financial sector was gambling on the rise of the housing market, yet no single regulator could see that everyone, from mortgage brokers to credit default swap traders, was betting on a bubble that was about to burst. Instead, each agency viewed its regulated market through a narrow lens, missing the total risk that permeated our financial markets.

In order to prevent this problem from recurring, a single financial regulator must be tasked with understanding the full range of risks our financial system faces. This regulator also must have the authority to take proactive steps to prevent or minimize systemic risk.

This is an urgent need. Unemployment reached 7.8 percent in my home State in January. Last month, the national unemployment rate hit 8.1 percent, the highest in 25 years. Earlier this month, the Federal Reserve reported that the net worth of American households plummeted by more than $11 trillion in 2008, a staggering drop of nearly 20 percent, the most in 63 years. And, at the same time, court proceedings and congressional hearings on the Bernie Madoff case revealed that this multibillion-dollar Ponzi scheme of nonexistent transactions and fraudulent statements was perpetrated for years under the very noses of the Federal agencies that should have stopped it.

The American people need more than words of optimism or promises of a turnaround. With their jobs lost or in jeopardy, with their financial plans in ruin, and now with their hard-earned tax dollars on the line to clean up the mess, they need reforms. They need action.

The American people are angry, and rightfully so. They are angry because the current crisis was not created from their own bad investments or decisions, but by those on Wall Street who concocted complicated financial instruments that ended up backfiring. Investment firms borrowed to the hilt when they did not have the resources to do so.

When the average American decides to purchase a security on credit, margin requirements dictate that he or she put up at least 50 percent of its value in cash. But investment banks did not have to play by the same rules when they bought for their own accounts. And they took advantage of this system.

Indicative of the extent of the borrowing, Bear Stearns had a leverage ratio of 35 to 1, which means the firm borrowed $35 for every dollar of its own money. For example, suppose your net worth is a dollar and you combine that dollar with $35 in borrowed money to buy an asset worth $36. If the value of that asset declines by only $2, to $34, you are now bankrupt. This is exactly what happened to Bear Stearns and other investment banks.

Since last spring, the Homeland Security and Governmental Affairs Committee, on which I serve as ranking member, has held a series of hearings on the roots of the present crisis. We began by looking at the derivatives and commodity markets and more recently looked at the steps that can be taken to protect our Nation's financial system as a whole by creating a systemic-risk regulator. The many expert witnesses who have appeared before us have described how our financial system was destabilized by a combination of reckless lending, complex new instruments, securitization of assets, poor disclosure and understanding of risks, excessive leverage, and inadequate regulation.

Our witnesses were in wide agreement that the mounting risk went virtually undetected by the vast network of Federal and State regulatory agencies. As the Government Accountability Office put it in a recent report to the committee, ``it has become apparent that the regulatory system is ill-suited to meet the nation's needs in the 21st century.'' To meet this challenge, Federal Reserve Chairman Bernanke said recently:

We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components.

This statement confirms a view that I find inescapable, our current system suffers from regulatory gaps that pose enormous risks to our entire economy. The holistic approach recommended by Chairman Bernanke is the guiding principle of the comprehensive legislation I introduce today. Like legislation I introduced last fall, this bill would also regulate Wall Street investment banks for safety and soundness and close the gap that has allowed credit default swaps and other financial instruments to escape regulation by both Federal and State regulators.

To ensure a systemic approach to Federal financial regulation, this legislation calls for the creation of an independent financial stability council to serve as a ``systemic-risk regulator.'' The council would maintain comprehensive oversight of all potential risks to the financial system, and would have the power to act to prevent or mitigate those risks. The financial stability council would be composed of representatives from existing Federal agencies which now have the responsibility to oversee segments of the financial system--the Federal Reserve; the Treasury Department; the Securities and Exchange Commission; the Commodity Futures Trading Commission; the Federal Deposit Insurance Corporation; and the National Credit Union Administration.

The council would be led by a chairman nominated by the President and confirmed by the Senate, with the responsibility for the day-to-day operations of the council. The chairman would be required to appear before Congress twice a year to report on the state of the country's financial system, areas in which systemic risk are anticipated, and whether any legislation is needed for the council to carry out its mission of preventing systemic risks.

Witnesses who have appeared before our committee have stressed the need to ensure that the systemic-risk regulator has the responsibility and the authority to ensure that risks to our financial system are identified and addressed. If it is not clear who has that responsibility, then agencies will dig in their heels and resist changes they do not agree with, and engage in finger-pointing when things go bad. At the same time, other witnesses have stressed the dangers of consolidating too much power in the hands of a single regulator and the need to maintain the level of oversight Congress has historically exercised with respect to financial market regulation.

The financial stability council created by this legislation balances these concerns. As Damon Silvers, the AFL-CIO representative on the TARP congressional oversight panel, testified before our committee earlier this month:

[T]he best approach is a body made up of the key regulators. ..... It is unlikely a systemic risk regulator would develop deep enough expertise on its own. ..... To be effective it would need to cooperate. ..... with all the routine regulators where the relevant expertise would be resident. .....

Former Senator John Sununu, another member of the congressional oversight panel, recognized that ``systemic risk can materialize in a broad range of areas within our financial system. ..... Thus, it is impractical, and perhaps a dangerous concentration of power, to give one single regulator the power to set or modify any and all standards relating to such risk. Systemic risk oversight and management must be a collaborative effort. .....''

The financial stability council will be the primary entity responsible for detecting systemic risk and implementing the steps necessary to protect against that risk. The key to such a structure, I believe, is to ensure that the council is headed by a chairman confirmed by the Senate and subject to oversight by Congress, who is dedicated entirely to the mission of the council, and who does not carry a bias in favor of any particular agency on the council.

Some have suggested that the Federal Reserve play the role of systemic-risk regulator. That is not what my bill contemplates. The chairman of the Federal Reserve will be a member of the council, and of course, the Nation's top banker will play a critical role in how the council discharges its responsibilities. But in my view, the Federal Reserve already has enough on its plate, and does not need additional, heavy responsibilities. I should add that nothing in my bill alters the Federal Reserve's role with respect to monetary policy in any way.

This bill, however, would apply safety and soundness regulation to investment bank holding companies by assigning the Federal Reserve this responsibility. Although the five big firms have left the field, this is a necessary step. Any new investment bank would fall into the same regulatory void as its predecessors. The SEC would be able to regulate its broker-dealer operations, but no agency would have the explicit authority to examine its operations for safety and soundness or for systemic risk. The collapses at Bear Stearns and Lehman Brothers illustrate the tremendous costs that can be inflicted if these investment banks are not regulated for safety and soundness. Under this legislation, the council's role as the systemic-risk regulator will support the critical importance of the Federal Reserve's safety and soundness duties.

Under my bill, whenever the financial stability council believes that a risk to the financial system is present due to a lack of proper regulation, or by the appearance of new and unregulated financial products or services, it would have the power to propose changes to regulatory policy, using the statutory authority provided to our existing Federal financial regulatory agencies.

The financial stability council will have the power to obtain information directly from any regulated provider of financial products and, in limited form, from State regulators regarding the solvency of State-regulated insurers.
The council will also be able to propose regulations of financial instruments which are designed to look like insurance products, but that in reality are financial products which could present a systemic risk. But--and I want to stress this point--my bill does not preempt State law governing traditional insurance products.

In keeping with the recommendations of the experts who testified before our committee, the bill provides the council with the power to adopt rules designed to address the ``too big to fail'' problem. How often we have heard that term lately. We hear financial experts and Federal officials telling us we have to continue to bail out large institutions like AIG because they are ``too big to fail.'' We need to remedy this problem so we don't find ourselves in the same situation a decade from now. This bill provides the council with the power to adopt rules designed to discourage financial institutions from becoming ``too big to fail'' or to regulate them appropriately if they become what we call ``systemically important financial institutions.'' The need to regulate how these systemically important financial institutions, or ``SIFIs,'' invest their own capital was not previously recognized. Indeed, the prevailing attitude was that if firms failed because of bad investments, possibly bringing some of their creditors down with them, that was how the market was supposed to work. In true Darwinian fashion, eliminating firms with less investment acumen would only serve to strengthen American capitalism. We now know the fallacy of that reasoning, and it has been a very painful lesson, for it is not just the large investment houses that are hurt, but average Americans from Maine to California also suffer.

Under this legislation the council would help make sure financial institutions do not become ``too big to fail'' by imposing different capital requirements on them as they grow in size, raising their risk premiums, or requiring them to hold a larger percentage of their debt as long-term debt. The TARP congressional oversight panel adopted this position, explaining:

We should not identify specific institutions in advance as too big to fail, but rather have a regulatory framework in which institutions have higher capital requirements and pay more on insurance funds on a percentage basis than smaller institutions which are less likely to be rescued as being too systemic to fail.

I want to make clear, though, that the power this bill provides to the council is not meant to restrict financial institutions from growing in size, but rather from becoming risks to the system as a whole.

The bill also provides the council with authority to address so-called regulatory ``black holes,'' created by new and imaginative financial instruments that do not fall within the jurisdictional authority of any Federal financial regulatory agency. Credit default swaps are a perfect example of this problem. Prior to 2000, credit default swaps existed in a regulatory limbo. Neither the SEC nor the CFTC were willing to exert authority over the credit default swap market. As a result, they fell through the jurisdictional cracks. Congress then compounded the problem by explicitly exempting credit default swaps from regulation under the Commodity Futures Modernization Act of 2000.

As was the case with AIG, serious problems can arise when a major ``credit event'' suddenly reveals that massive claims for collateral posting or payment are converging on credit default swap parties who cannot meet their obligations. But because the market was bilateral and over-the-counter, it was often impossible for regulators--and even market participants--to know in advance how all the tangled webs of contract commitments overlapped and affected any particular party. Under the current system which lacks a systemic-risk regulator, regulators at times lack the authority to take action against excessive debt, inadequate reserves, and other threats, even when they see them occurring.

This legislation specifically addresses the credit default swap problem by repealing the exemption from regulation that Congress created for these instruments in 2000, and by setting up a government-regulated clearinghouse.

But beyond credit default swaps, risky new financial instruments could still avoid the reach of our regulatory system. For that reason, my legislation provides the council with the power to propose regulations and legislation governing the sale or marketing of any financial instrument which would fall into a ``black hole,'' and would otherwise present a systemic risk to the financial systems of the United States if left unmonitored.

Professor Howell Jackson, the acting dean of Harvard Law School, discussed this ``black hole'' problem in his testimony to our committee early this year. He stated that the underlying issue is that ``well-advised financial services firms are capable of exploiting the legalistic boundaries of jurisdictional authority that characterize our system of financial regulation. Without broad jurisdictional mandates, our financial regulators will remain at a serious disadvantage in setting policy for new financial products and risks.''

Finally, my bill will merge the Office of Thrift Supervision, OTS, into the Office of the Comptroller of the Currency, OCC. Secretary Paulson recommended this merger in the plan he released last year, and 2 years ago, John Dugan, the U.S. Comptroller, said that such a merger would be ``appropriate and healthy.'' There are currently at least four agencies involved in bank regulation, including the FDIC, the Federal Reserve, and the OCC and OTC. Consolidating and reducing the number of banking regulators would improve the efficiency and effectiveness of this system.

OTS is the best candidate for several reasons, including that many of its largest regulated entities, thrifts, have either collapsed or been acquired in the midst of the financial crisis--such as Washington Mutual and Indy Mac. And in the last 4 months, the inspector general for Treasury has raised serious questions about the objectivity and effectiveness of OTS's supervision of the largest thrifts.

Mr. President, the regulatory reforms in this legislation are absolutely essential to restoring public confidence in our financial markets. We have relied too long on a patchwork of regulatory agencies that is incapable of understanding or controlling risks to the system as a whole. The overarching purpose of this legislation is to ensure that, as the financial-services industry becomes ever more global and complex, those in government, responsible for overseeing the system's stability, can see the whole picture. We are in this crisis precisely because firms, whether for good or bad, exploited legal boundaries, risky financial instruments fell beyond the reach of regulators, and institutions doomed to fail grew too big to fail.

Honest savers, borrowers, investors, Main Street businesses, and responsible financial institutions deserve a regulatory system suited to demands of modern times, where dangerous gaps are closed, and where risky transactions are indentified and controlled before they pose a threat to the markets as a whole. These reforms must be made to restore the confidence necessary to stabilize our financial markets. That is what this legislation aims to do, and I urge my colleagues to support it.

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