Travel Promotion Act of 2009--Motion to Proceed--Continued

Floor Speech

TRAVEL PROMOTION ACT OF 2009--MOTION TO PROCEED--Continued -- (Senate - June 16, 2009)

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SYSTEMIC RISK REGULATION

Mr. WARNER. Mr. President, I rise today to discuss the state of our financial system and to provide some thoughts on systemic risk regulation, as we set about crafting an overall reform to our financial regulatory approach.

Yesterday, Treasure Secretary Timothy Geithner and the Director of the National Economic Council, Lawrence Summers, published an editorial in the Washington Post laying out the broad outline of their proposal for regulatory reform. I share their views on how we arrived at this moment. I share the broader goals they discussed and look forward to working with the administration on comprehensive and timely regulatory reform. However, I wish to speak today about one area where I disagree, and that is how to address systemic risk.

Let me step back for a moment.

In the past 2 years we have witnessed events that have shaken our financial system to its core, altered our markets in ways that we still struggle to understand, and imposed costs that will burden our economy and our taxpayers for decades to come. We have grown numb to the news, but let me briefly recount these events.

The investment banking sector that built our capital markets has collapsed. Two of our largest investment banks have failed. Another has merged
with a commercial bank to avoid failure. Two others became commercial banking organizations.

Our residential mortgage finance sector has collapsed. The largest mortgage banks in the country have failed. Our two largest savings and loan associations have failed. Our two largest housing GSEs are operating under Federal Government conservatorship.

Our commercial banking sector has avoided collapse only through the infusion of hundreds of billions of dollars in equity support from the U.S. Treasury and massive liquidity support from the FDIC and the Federal Reserve. And despite these interventions, some of our largest commercial banks continue to face an uncertain future and dozens of smaller commercial banks have failed. Our insurance sector has been badly damaged. The largest insurance organization in the United States has been nationalized to avoid collapse. Other major insurers have received billions of dollars from the Treasury.

The magnitude of the events of the past 2 years strains comprehension. I believe what we have seen over the last couple years is the equivalent, in economic terms, of the 100-year flood. Millions of families and retirees have lost their financial security. Millions of people are out of work. Each day, we read about more layoffs, more losses, more bankruptcies, and more bank failures. We call this a financial crisis, but for the American people it is a very personal crisis of lost homes, derailed careers, forgone education, deferred retirement, communities less cared for, and at its core, the confidence of the American people has been shaken.

This crisis has uncovered the flaws of our current regulatory model and has revealed a shadow financial system which lies beyond the current regulatory structure.

We all share the hope that we will soon return to healthy, competitive financial markets and a vibrant economy. We have seen some positive signs that markets are stabilizing. But for our long-term prosperity, we do need a new model. What has happened to our financial system and our economy should not have happened. We must find and adopt reforms that will ensure that it never happens again.

We cannot shrink from the needed reform because it will be difficult or because some will oppose it. Right now there is a lack of faith in our system or its long term prospects. You can see that in our bond markets. We are not turning to the financial sector as a source of positive innovation so that the broader economy can grow. You can see that in the lack of credit in our markets, and the jobs lost every month.

To innovate and create jobs, not only in the financial system but across our whole economy, we do need comprehensive reform. Quality will attract capital, but only change will restore the quality of our markets.

This is the fundamental challenge facing the Banking Committee, of which I am a new member. However, before I joined this Banking Committee, before I joined this August body, I did spend 20 years in the private sector around the financial system, taking companies public, looking at and learning about the markets. So I came to this body, I believe, with some background. But only since that time have I learned how complex the problems and the challenges are of trying to get financial reregulation or financial reform right.

Since joining the Banking Committee, I have been working to educate myself, meeting with a range of experts to learn more about the issues and to collect their thoughts on potential solutions to financial reregulation. There are a number of things we must do, including providing full regulatory coverage for all markets, ending too big to fail with a robust resolution authority, and ending regulatory arbitrage.

Today I would like to speak about one issue I discussed at length with these experts--systemic risk regulation. I hope, in the coming days, to come back to the floor and discuss other parts of securities and banking regulation.

``Systemic risk'' is a term that, quite candidly, probably most of us even around the financial markets had not even heard of or thought very much about until the last couple years. Obviously, systemic risk is not the only area we need to address, but it is an area in which the current system has unequivocally failed.

Systemic risk is a tricky concept. Systemic risk is not a specific kind of risk at all. It is a catchall phrase that includes risks of all kinds, united only by the possibility that if left uncontrolled, they could have consequences for entire markets or even our entire financial system. Counterparty exposures can present systemic risk. So can interest rate shifts. So can bad laws and regulations. Because they come in all shapes and sizes, we should not expect to control systemic risks with a rigid, one-size-fits-all approach.

Our current system has failed to provide checks and balances and has replaced healthy competition with a system where a handful of firms are called too large to fail, and these so-called too-large-to-fail firms can threaten the safety of the entire system and, unfortunately, enjoy an implicit or even now even more explicit government guarantee that destroys any notion of market competition.

Secretary Geithner and Professor Summers have proposed empowering the Federal Reserve to manage systemic risk. But as I have discussed this approach with a number of experts, they have raised a number what of what I think are very serious and legitimate concerns.

My primary concern with placing this added new responsibility with the Federal Reserve is structural. There are already tensions between the Federal Reserve's responsibilities for the conduct of monetary policy and its responsibilities for bank supervision. No less an authority on this matter than Paul Volcker told the Joint Economic Committee last year that broadening the Federal Reserve's responsibilities ``would be a way of destroying the Federal Reserve in the long run, because it does need independence.'' Adding this additional responsibility on the Federal Reserve, I believe, is a step too far.

My other concern is rooted in the governing philosophy of this country, which I think has, quite honestly, served us well. That philosophy is that too much economic power placed in one place puts our system of government at risk.

Our Founding Fathers opposed that concentration of power, economic or otherwise, and favored a system of checks and balances. Thomas Jefferson famously wrote that ``[t]he Central Bank is an institution of the most deadly hostility existing against the principles and form of our Constitution.'' That is why America, unlike so many European countries, never created a single, all-powerful national bank. We have, consequently, even since that time, resisted creating that all-powerful central bank. The experience of countries which have concentrated too much power in one entity I think should serve as cautionary tales.

Also, we should not ignore that the Fed has had some responsibility for systemic risk regulation under the current structure. Over the course of the past year, we have seen the Federal Reserve and the Treasury strike private deals with our largest and most powerful financial institutions--deals that might have protected the shareholders and creditors of those banks, but, consequently, by those actions, put smaller and less powerful and often better run institutions at a competitive disadvantage and undermining the long-term vitality of our financial system.

An old African proverb says that when elephants dance, the grass gets trampled. We have a trampled grass problem at this point, and I don't think we can solve it with bigger elephants, whether those bigger elephants are regulators or institutions. If we do not give the Federal Reserve the responsibility for systemic risk regulation, what should we do instead?

I believe the answer to this question has two parts. The first part is that many systemic risks already lie squarely within the responsibilities of the day-to-day financial regulators. We did not just discover systemic risks. We have been discovering them for generations. We have passed laws to deal with them, and we have entrusted those laws to the administration of substantial regulatory agencies.

We need to make sure our current regulators, the folks who, for the most of the last century, have done their jobs well, have clear missions, including managing risks within their regulated institutions and markets, and we
must ensure that these regulators do their jobs.

But that is only half the problem. Even if we get the day-to-day prudential regulator to be more efficient in evaluating particular institutions' risk profile, we have to recognize that some part of systemic risk may lay outside of the regulator's day-to-day responsibilities and actually fall between the cracks of our existing regulatory system.

Working with folks across the financial spectrum, they have suggested the creation of a systemic risk council. I don't mean to claim on this floor that a systemic risk council is a silver bullet, but it avoids the pitfalls of entrusting the systemic risk responsibility in one agency that already has responsibilities and can be a potential source of conflict. Instead, a council can see across the horizon and gather all the information and expertise can flow to it, thereby addressing our stovepipe problem of our various regulatory agencies and making sure, as well, by having this council, it would have the intrinsic conflicts that would come if you also have to have responsibility for monetary policy. Making sure we have this council would also avoid the very real challenge of regulatory capture. Let me briefly outline this concept.

Our belief would be the systemic risk council would consist of the Treasury Secretary, the Chairman of the Federal Reserve, and the heads of the major financial regulatory agencies. It would be charged with the responsibility for working to improve our understanding and control of systemic risks and, in a narrow set of circumstances or emergencies, it would have the ability to act.

People would say: What does this look like? It builds on the model of the President's working group on financial markets. The idea is, the systemic risk council would have an independent chair appointed by the President and approved by the Congress and supported by a permanent staff. The best analogy of the systemic risk council might be the resemblance it might bear to the National Transportation Safety Board or the National Security Council. Just as the NTSB leaves rulemaking on a day-to-day basis to the FAA, the systemic risk council would leave most of the day-to-day rulemaking to the financial regulatory agency.

I understand criticism of the council's approach today is we don't just want a debating society at moments of crisis. That is why it needs this independent chair, independent staff, and resources. We must ensure it could act.

It would have the authority to review every bit of information that the individual, prudential, day-to-day Federal regulatory agencies possess, to require those agencies to collect information from the institutions they regulate.

It would also have, as I mentioned, an independent staff capable of analyzing this data, understanding how the pieces of the regulatory system work together, and then at that council level, at that staff level, feed that information up to the council so it could identify weaknesses or gaps within our system or potential systemic risks that might be arising outside the purview of the independent Federal regulatory agency.

The council would also have the authority to require the financial regulators to develop clear, written plans for dealing with potential financial crises. In effect, it would have the potential to ask any institution to come forward with a winddown resolution plan for its particular circumstances. These plans would be created in advance of any crisis, maintained and even simulated from time to time to make sure they are adequate.

Again, if we put in place these kinds of credible plans to handle the potential failure of every systemically important financial institution, then we will no longer have the excuse that we have constantly heard over the last few months: Gosh, it is tough we have to put up this much public money to support this institution, but it is too big to fail.

As we have seen time and again in this crisis, because we didn't have these plans in place, unfortunately, the American taxpayers have taken on unfounded, quite honestly, financial risk in shoring up these institutions.

Because a systemic risk council would not directly interact with our major financial institutions on a day-to-day basis, it would be less prone to capture than the financial regulatory agencies. During normal times, the council could help to determine how to regulate new products and markets in order to minimize regulatory gaps, regulatory arbitrage, and the blind spots that currently exist in our system. As we know at this point, too many of those blind spots exist and have allowed the creation of some of the financial products that led to the financial meltdown we have seen.

The council will not identify firms that are too big or too large to fail but instead will work to prevent firms from becoming too large to fail. It would do this specifically in two ways.

First, it would have the authority to establish systemwide, counterparty exposure limits, increased capital requirements, reduced leverage, and strengthened risk management requirements--all of these, in effect, to put not an absolute prescription but at least barriers on those institutions that choose to get so large that they might potentially fall into that ``too big to fail'' category.

Second, it would ensure that the resolution authority would be able to resolve any institution that got to that size and then potentially posed a systemic risk.

In a crisis, the council could work with its member organizations to promote coordinated and comprehensive responses. The systemic risk council's responsibilities would be clear and focused. Systemic risk would be its only job.

Using a council, prudential regulators would remain empowered and responsible for systemic risks that arose in their jurisdiction. If they encountered a risk that extended beyond their authority they could go to the council to ensure coordinated and comprehensive action. On top of that, if the evidence of risk is spread across different agencies like pieces of a puzzle, the council would have the information and expertise to spot it, and the ability to coordinate action in order to address it.

What I am proposing today boils down to a simple, commonsense idea. If we want to do something constructive about systemic risk, we should create a mechanism that can help ensure our regulators do their jobs on a day-to-day basis, avoid conflicts of interest, and fully leverage our existing regulatory resources to promote the proactive identification and control of systemic risks.

Let me acknowledge at the outset that there are many details that still need to be worked out, and I will, as I mentioned, have a series of other ideas of how we can modernize our financial system in the coming weeks ahead. But I believe the general approach I have outlined today, in terms of a systemic risk council, hopefully, will spark the debate so we do not simply default to further empowering an already extraordinarily important and critical institution, in terms of the Federal Reserve, without a thorough debate about this issue.

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