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Report to Congressional Addressees: 

United States Government Accountability Office: 
GAO: 

January 2009: 

Financial Regulation: 

A Framework for Crafting and Assessing Proposals to Modernize the 
Outdated U.S. Financial Regulatory System: 

GAO-09-216: 

GAO Highlights: 

Highlights of GAO-09-216, a report to congressional addressees. 

Why GAO Did This Study: 

The United States and other countries are in the midst of the worst 
financial crisis in more than 75 years. While much of the attention of 
policymakers understandably has been focused on taking short-term steps 
to address the immediate nature of the crisis, these events have served 
to strikingly demonstrate that the current U.S. financial regulatory 
system is in need of significant reform. 

To help policymakers better understand existing problems with the 
financial regulatory system and craft and evaluate reform proposals, 
this report (1) describes the origins of the current financial 
regulatory system, (2) describes various market developments and 
changes that have created challenges for the current system, and (3) 
presents an evaluation framework that can be used by Congress and 
others to shape potential regulatory reform efforts. To do this work, 
GAO synthesized existing GAO work and other studies and met with dozens 
of representatives of financial regulatory agencies, industry 
associations, consumer advocacy organizations, and others. Twenty-nine 
regulators, industry associations, and consumer groups also reviewed a 
draft of this report and provided valuable input that was incorporated 
as appropriate. In general, reviewers commented that the report 
represented an important and thorough review of the issues related to 
regulatory reform. 

What GAO Found: 

The current U.S. financial regulatory system has relied on a fragmented 
and complex arrangement of federal and state regulators—put into place 
over the past 150 years—that has not kept pace with major developments 
in financial markets and products in recent decades. As the nation 
finds itself in the midst of one of the worst financial crises ever, 
the regulatory system increasingly appears to be ill-suited to meet the 
nation’s needs in the 21st century. Today, responsibilities for 
overseeing the financial services industry are shared among almost a 
dozen federal banking, securities, futures, and other regulatory 
agencies, numerous self-regulatory organizations, and hundreds of state 
financial regulatory agencies. Much of this structure has developed as 
the result of statutory and regulatory changes that were often 
implemented in response to financial crises or significant developments 
in the financial services sector. For example, the Federal Reserve 
System was created in 1913 in response to financial panics and 
instability around the turn of the century, and much of the remaining 
structure for bank and securities regulation was created as the result 
of the Great Depression turmoil of the 1920s and 1930s. 

Several key changes in financial markets and products in recent decades 
have highlighted significant limitations and gaps in the existing 
regulatory system. 

* First, regulators have struggled, and often failed, to mitigate the 
systemic risks posed by large and interconnected financial 
conglomerates and to ensure they adequately manage their risks. The 
portion of firms operating as conglomerates that cross financial 
sectors of banking, securities, and insurance increased significantly 
in recent years, but none of the regulators is tasked with assessing 
the risks posed across the entire financial system. 

* Second, regulators have had to address problems in financial markets 
resulting from the activities of large and sometimes less-regulated 
market participants—such as nonbank mortgage lenders, hedge funds, and 
credit rating agencies—some of which play significant roles in today’s 
financial markets. 

* Third, the increasing prevalence of new and more complex investment 
products has challenged regulators and investors, and consumers have 
faced difficulty understanding new and increasingly complex retail 
mortgage and credit products. Regulators failed to adequately oversee 
the sale of mortgage products that posed risks to consumers and the 
stability of the financial system. 

* Fourth, standard setters for accounting and financial regulators have 
faced growing challenges in ensuring that accounting and audit 
standards appropriately respond to financial market developments, and 
in addressing challenges arising from the global convergence of 
accounting and auditing standards. 

* Finally, despite the increasingly global aspects of financial 
markets, the current fragmented U.S. regulatory structure has 
complicated some efforts to coordinate internationally with other 
regulators. 

As a result of significant market developments in recent decades that 
have outpaced a fragmented and outdated regulatory structure, 
significant reforms to the U.S. regulatory system are critically and 
urgently needed. The current system has important weaknesses that, if 
not addressed, will continue to expose the nation’s financial system to 
serious risks. As early as 1994, GAO identified the need to examine the 
federal financial regulatory structure, including the need to address 
the risks from new unregulated products. Since then, GAO has described 
various options for Congress to consider, each of which provides 
potential improvements, as well as some risks and potential costs. This 
report offers a framework for crafting and evaluating regulatory reform 
proposals; it consists of the following nine characteristics that 
should be reflected in any new regulatory system. By applying the 
elements of this framework, the relative strengths and weaknesses of 
any reform proposal should be better revealed, and policymakers should 
be able to focus on identifying trade-offs and balancing competing 
goals. Similarly, the framework could be used to craft proposals, or to 
identify aspects to be added to existing proposals to make them more 
effective and appropriate for addressing the limitations of the current 
system. 

Table: 

Characteristic: Clearly defined regulatory goals; Description: Goals 
should be clearly articulated and relevant, so that regulators can 
effectively carry out their missions and be held accountable. Key 
issues include considering the benefits of re-examining the goals of 
financial regulation to gain needed consensus and making explicit a set 
of updated comprehensive and cohesive goals that reflect today’s 
environment. 

Characteristic: Appropriately comprehensive; Description: Financial 
regulations should cover all activities that pose risks or are 
otherwise important to meeting regulatory goals and should ensure that 
appropriate determinations are made about how extensive such 
regulations should be, considering that some activities may require 
less regulation than others. Key issues include identifying risk-based 
criteria, such as a product’s or institution’s potential to create 
systemic problems, for determining the appropriate level of oversight 
for financial activities and institutions, including closing gaps that 
contributed to the current crisis. 

Characteristic: Systemwide focus; 
Description: Mechanisms should be included for identifying, monitoring, 
and managing risks to the financial system regardless of the source of 
the risk. Given that no regulator is currently tasked with this, key 
issues include determining how to effectively monitor market 
developments to identify potential risks; the degree, if any, to which 
regulatory intervention might be required; and who should hold such 
responsibilities. 

Characteristic: Flexible and adaptable; Description: A regulatory 
system that is flexible and forward looking allows regulators to 
readily adapt to market innovations and changes. Key issues include 
identifying and acting on emerging risks in a timely way without 
hindering innovation. 

Characteristic: Efficient and effective; Description: Effective and 
efficient oversight should be developed, including eliminating 
overlapping federal regulatory missions where appropriate, and 
minimizing regulatory burden without sacrificing effective oversight. 
Any changes to the system should be continually focused on improving 
the effectiveness of the financial regulatory system. Key issues 
include determining opportunities for consolidation given the large 
number of overlapping participants now, identifying the appropriate 
role of states and self-regulation, and ensuring a smooth transition to 
any new system. 

Characteristic: Consistent consumer and investor protection; 
Description: Consumer and investor protection should be included as 
part of the regulatory mission to ensure that market participants 
receive consistent, useful information, as well as legal protections 
for similar financial products and services, including disclosures, 
sales practice standards, and suitability requirements. Key issues 
include determining what amount, if any, of consolidation of 
responsibility may be necessary to streamline consumer protection 
activities across the financial services industry. 

Characteristic: Regulators provided with independence, prominence, 
authority, and accountability; Description: Regulators should have 
independence from inappropriate influence, as well as prominence and 
authority to carry out and enforce statutory missions, and be clearly 
accountable for meeting regulatory goals. With regulators with varying 
levels of prominence and funding schemes now, key issues include how to 
appropriately structure and fund agencies to ensure that each one’s 
structure sufficiently achieves these characteristics. 

Characteristic: Consistent financial oversight; Description: Similar 
institutions, products, risks, and services should be subject to 
consistent regulation, oversight, and transparency, which should help 
minimize negative competitive outcomes while harmonizing oversight, 
both within the United States and internationally. Key issues include 
identifying activities that pose similar risks, and streamlining 
regulatory activities to achieve consistency. 

Characteristic: Minimal taxpayer exposure; Description: A regulatory 
system should foster financial markets that are resilient enough to 
absorb failures and thereby limit the need for federal intervention and 
limit taxpayers’ exposure to financial risk. Key issues include 
identifying safeguards to prevent systemic crises and minimizing moral 
hazard. 

Source: GAO. 

[End of table] 

[End of section] 

Contents: 

Letter: 

Background: 

Today's Financial Regulatory System Was Built over More Than a Century, 
Largely in Response to Crises or Market Developments: 

Changes in Financial Institutions and Their Products Have Significantly 
Challenged the U.S. Financial Regulatory System: 

A Framework for Crafting and Assessing Alternatives for Reforming the 
U.S. Financial Regulatory System: 

Comments from Agencies and Other Organizations, and Our Evaluation: 

Appendix I: Scope and Methodology: 

Appendix II: Agencies and Other Organizations That Reviewed the Draft 
Report: 

Appendix III: Comments from the American Bankers Association: 

Appendix IV: Comments from the American Council of Life Insurers: 

Appendix V: Comments from the Conference of State Bank Supervisors: 

Appendix VI: Comments from Consumers Union: 

Appendix VII: Comments from the Credit Union National Association: 

Appendix VIII: Comments from the Federal Deposit Insurance Corporation: 

Appendix IX: Comments from the Mortgage Bankers Association: 

Appendix X: Comments from the National Association of Federal Credit 
Unions: 

Appendix XI: Comments from the Center for Responsible Lending, the 
National Consumer Law Center, and the U.S. PIRG: 

Appendix XII: GAO Contacts and Staff Acknowledgments: 

Related GAO Products: 

Figures: 

Figure 1: Formation of U.S. Financial Regulatory System (1863-2008): 

Figure 2: Key Developments and Resulting Challenges That Have Hindered 
the Effectiveness of the Financial Regulatory System: 

Figure 3: Status of Top 25 Subprime and Nonprime Mortgage Lenders 
(2006): 

Figure 4: Growth in Proportion of Private Label Securitization in the 
Mortgage-Backed Securities Market, in Dollars and Percentage of Dollar 
Volume (1995-2007): 

Figure 5: Example of an Off-Balance Sheet Entity: 

Abbreviations: 

BFCU: Bureau of Federal Credit Unions: 

CDO: collateralized debt obligation: 

CEC: Commodity Exchange Commission: 

CFTC: Commodity Futures Trading Commission: 

CSE: Consolidated Supervised Entity: 

FASB: Financial Accounting Standards Board: 

FDIC: Federal Deposit Insurance Corporation: 

FHFA: Federal Housing Finance Agency: 

FHFB: Federal Housing Finance Board: 

FHLBB: Federal Home Loan Bank Board: 

FRS: Federal Reserve System: 

FSLIC: Federal Savings and Loan Insurance Corporation: 

FTC: Federal Trade Commission: 

GFA: Grain Futures Administration: 

GLBA: Gramm-Leach-Bliley Act of 1999: 

GSE: government-sponsored enterprise: 

IMF: International Monetary Fund: 

LTCM: Long Term Capital Management: 

NAIC: National Association of Insurance Commissioners: 

NCUA: National Credit Union Administration: 

NRSRO: nationally recognized statistical rating organization: 

OCC: Office of the Comptroller of the Currency: 

OFHEO: Office of Federal Housing Enterprise Oversight: 

OTC: over-the-counter: 

OTS: Office of Thrift Supervision: 

PCAOB: Public Company Accounting Oversight Board: 

SEC: Securities and Exchange Commission: 

SRO: self-regulatory organization: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548: 

January 8, 2009: 

Congressional Addressees: 

The United States is in the midst of the worst financial crisis in more 
than 75 years. In recent months, federal officials have taken 
unprecedented steps to stem the unraveling of the financial services 
sector by committing trillions of dollars of taxpayer funds to rescue 
financial institutions and restore order to credit markets, including 
the creation of a $700 billion program that has been used so far to 
inject money into struggling institutions in an attempt to stabilize 
markets.[Footnote 1] This current crisis largely stems from defaults on 
U.S. subprime mortgage loans, many of which were packaged and sold as 
securities to buyers in the United States and around the world. With 
financial institutions from many countries participating in these 
activities, the resulting turmoil has afflicted financial markets 
globally and has spurred coordinated action by world leaders in an 
attempt to protect savings and restore the health of the markets. While 
much of policymakers' attention understandably has been focused on 
taking short-term steps to address the immediate nature of the crisis, 
these events have served to strikingly demonstrate that the current 
U.S. financial regulatory system is in need of significant reform. 
[Footnote 2] 

The current U.S. regulatory system has relied on a fragmented and 
complex arrangement of federal and state regulators--put into place 
over the past 150 years--that has not kept pace with the major 
developments that have occurred in financial markets and products in 
recent decades. In particular, the current system was not designed to 
adequately oversee today's large and interconnected financial 
institutions, whose activities pose new risks to the institutions 
themselves as well as risk to the broader financial system--called 
systemic risk, which is the risk that an event could broadly effect the 
financial system rather than just one or a few institutions. In 
addition, not all financial activities and institutions fall under the 
direct purview of financial regulators, and market innovations have led 
to the creation of new and sometimes very complex products that were 
never envisioned as the current regulatory system developed. In light 
of the recent turmoil in financial markets, the current financial 
regulatory system increasingly appears to be ill-suited to meet the 
nation's needs in the 21st century. 

As the administration and Congress continue to take actions to address 
the immediate financial crisis, determining how to create a regulatory 
system that reflects new market realities is a key step to reducing the 
likelihood that the U.S. will experience another financial crisis 
similar to the current one. As a result, considerable debate is under 
way over whether and how the current regulatory system should be 
changed, including calls for consolidating regulatory agencies, 
broadening certain regulators' authorities, or subjecting certain 
products or entities to more regulation. For example, in March 2008, 
the Department of the Treasury (Treasury) proposed significant 
financial regulatory reforms in its "Blueprint for a Modernized 
Financial Regulatory Structure," and other federal regulatory officials 
and industry groups have also put forth reform proposals.[Footnote 3] 
Under the Emergency Economic Stabilization Act, Treasury is required to 
submit to Congress by April 30, 2009, a report with recommendations on 
"the current state of the financial markets and the regulatory system." 
[Footnote 4] As these and other proposals are developed or evaluated, 
it will be important to carefully consider their advantages and 
disadvantages and long-term implications. 

To help policymakers weigh the various proposals and consider ways in 
which the current regulatory system could be made more effective and 
efficient, we prepared this report under the authority of the 
Comptroller General. Specifically, our report (1) describes the origins 
of the current financial regulatory system, (2) describes various 
market developments and changes that have raised challenges for the 
current system, and (3) presents an evaluation framework that can be 
used by Congress and others to craft or evaluate potential regulatory 
reform efforts going forward. This report's primary focus is on 
discussing how various market developments have revealed gaps and 
limitations in the existing regulatory system. Although drawing on 
examples of events from the current crisis, we do not attempt to 
identify all of the potential weaknesses in the actions of regulators 
that had authority over the institutions and products involved. 

To address these objectives, we synthesized existing GAO work on 
challenges to the U.S. financial regulatory structure and on criteria 
for developing and strengthening effective regulatory structures. 
[Footnote 5] We also reviewed existing studies, government documents, 
and other research for illustrations of how current and past financial 
market events have exposed inadequacies in our existing financial 
regulatory system and for suggestions for regulatory reform. In a 
series of forums, we discussed these developments and the elements of a 
potential framework for an effective regulatory system with groups of 
financial regulators of banking, securities, futures, insurance, and 
housing markets; representatives of financial services industry 
associations and individual financial institutions; and with selected 
consumer advocacy organizations, academics, and other experts in 
financial markets issues. The work upon which this report is based was 
conducted in accordance with generally accepted government auditing 
standards. Those standards require that we plan and perform the audit 
to obtain sufficient, appropriate evidence to provide a reasonable 
basis for our findings and conclusions based on our audit objectives. 
We believe that the evidence obtained provides a reasonable basis for 
our findings and conclusions based on our audit objectives. This work 
was conducted between April 2008 and December 2008. A more extensive 
discussion of our scope and methodology appears in appendix I. 

Background: 

While providing many benefits to our economy and citizens' lives, 
financial services activities can also cause harm if left unsupervised. 
As a result, the United States and many other countries have found that 
regulating financial markets, institutions, and products is more 
efficient and effective than leaving the fairness and integrity of 
these activities to be ensured solely by market participants 
themselves. 

The federal laws related to financial regulation set forth specific 
authorities and responsibilities for regulators, although these 
authorities typically do not contain provisions explicitly linking such 
responsibilities to overall goals of financial regulation. 
Nevertheless, financial regulation generally has sought to achieve four 
broad goals: 

* Ensure adequate consumer protections. Because financial institutions' 
incentives to maximize profits can in some cases lead to sales of 
unsuitable or fraudulent financial products, or unfair or deceptive 
acts or practices, U.S. regulators take steps to address informational 
disadvantages that consumers and investors may face, ensure consumers 
and investors have sufficient information to make appropriate 
decisions, and oversee business conduct and sales practices to prevent 
fraud and abuse. 

* Ensure the integrity and fairness of markets. Because some market 
participants could seek to manipulate markets to obtain unfair gains in 
a way that is not easily detectable by other participants, U.S. 
regulators set rules for and monitor markets and their participants to 
prevent fraud and manipulation, limit problems in asset pricing, and 
ensure efficient market activity. 

* Monitor the safety and soundness of institutions. Because markets 
sometimes lead financial institutions to take on excessive risks that 
can have significant negative impacts on consumers, investors, and 
taxpayers, regulators oversee risk-taking activities to promote the 
safety and soundness of financial institutions. 

* Act to ensure the stability of the overall financial system. Because 
shocks to the system or the actions of financial institutions can lead 
to instability in the broader financial system, regulators act to 
reduce systemic risk in various ways, such as by providing emergency 
funding to troubled financial institutions. 

Although these goals have traditionally been their primary focus, 
financial regulators are also often tasked with achieving other goals 
as they carry out their activities. These can include promoting 
economic growth, capital formation, and competition in our financial 
markets. Regulators have also taken actions with an eye toward ensuring 
the competitiveness of regulated U.S. financial institutions with those 
in other sectors or with others around the world. In other cases, 
financial institutions may be required by law or regulation to foster 
social policy objectives such as fair access to credit and increased 
home ownership. 

In general, these goals are reflected in statutes, regulations, and 
administrative actions, such as rulemakings or guidance, by financial 
institution supervisors. Laws and regulatory agency policies can set a 
greater priority on some roles and missions than others. Regulators are 
usually responsible for multiple regulatory goals and often prioritize 
them differently. For example, state and federal bank regulators 
generally focus on the safety and soundness of depository institutions; 
federal securities and futures regulators focus on the integrity of 
markets, and the adequacy of information provided to investors; and 
state securities regulators primarily address consumer protection. 
State insurance regulators focus on the ability of insurance firms to 
meet their commitments to the insured. 

The degrees to which regulators oversee institutions, markets, or 
products also vary depending upon, among other things, the regulatory 
approach Congress has fashioned for different sectors of the financial 
industry. For example, some institutions, such as banks, are subject to 
comprehensive regulation to ensure their safety and soundness. Among 
other things, they are subject to examinations and limitations on the 
types of activities they may conduct. Other institutions conducting 
financial activities are less regulated, such as by only having to 
register with regulators or by having less extensive disclosure 
requirements. Moreover, some markets, such as those for many over-the- 
counter derivatives markets, as well as activities within those 
markets, are not subject to oversight regulation at all. 

Today's Financial Regulatory System Was Built over More Than a Century, 
Largely in Response to Crises or Market Developments: 

As a result of 150 years of changes in financial regulation in the 
United States, the regulatory system has become complex and fragmented. 
(See figure 1) Our regulatory system has multiple financial regulatory 
bodies, including five federal and multiple state agencies that oversee 
depository institutions. Securities activities are overseen by federal 
and state government entities, as well as by private sector 
organizations performing self-regulatory functions. Futures trading is 
overseen by a federal regulator and also by industry self-regulatory 
organizations. Insurance activities are primarily regulated at the 
state level with little federal involvement. 

Figure 1: Formation of U.S. Financial Regulatory System (1863-2008): 

[Refer to PDF for image] 

This figure is a timeline of the formation of U.S. Financial Regulatory 
System, as follows: 

Civil War; 

1863 – National Bank Act: Established Office of the Comptroller of the 
Currency (OCC) (Federal agency-banking); 

1873-1907: Financial panics and instability; 

1913 – Federal Reserve Act: Established Federal Reserve System (FRS) 
(Federal agency-banking); 
[Financial Regulatory System now consists of: OCC, FRS] 

1922 – Grain Futures Act: Established the Grain Futures Administration 
(GFA) to oversee the trading of agricultural futures contracts; 
(Federal agency-securities and futures); 

1929-1938: Great Depression; 

1932 – Federal Home Loan Bank Act: Created the Federal Home Loan Bank 
Board (FHLBB) to oversee the Federal Home Loan Bank System (Federal 
agency-secondary mortgage markets); 
[Financial Regulatory System now consists of: OCC, FRS, GFA, and FHLBB] 

1933 – Banking Act: Established Federal Deposit Insurance Corporation 
(FDIC) (Federal agency-banking); 

1933 – Securities Act: Established federal regulation of securities 
issuances; 

1934 – Securities Exchange Act: Established Securities and Exchange 
Commission (SEC) (Federal agency-securities and futures); 

1934 – National Housing Act: Established Federal Savings and Loan 
Insurance Corporation (FSLIC) (Federal agency-banking); 

1934 – Federal Credit Union Act: Established Bureau of Federal Credit 
Unions (BFCU) (Federal agency-banking); 

1936 – Commodity Exchange Act: Commodity Exchange Commission (CEC) 
established from the Grain Futures Administration (Federal agency-
securities and futures); 
[Financial Regulatory System now consists of: OCC, FRS, FHLBB, FDIC, 
SEC, FSLIC, BFCU, CEC] 

1945 – McCarran-Ferguson Act: Delegated authority to regulate 
interstate insurance transactions to the states; 

1970 – Amendment to Federal Credit Union Act: National Credit Union 
Administration (NCUA) established from BFCU (Federal agency-banking); 

1974 – Commodity Futures Trading Commission Act: Commodity Futures 
Trading Commission (CFTC) established from CEC (Federal agency-
securities and futures); 

1986-1989: S&L Crisis; 

1989 – Financial Institutions Reform, Recovery, and Enforcement Act: 
Established Office of Thrift Supervision (OTS); FDIC absorbed FSLIC; 
Federal Housing Finance Board (FHFB) replaced FHLBB; 

1992 – Federal Housing Enterprises Financial Safety and Soundness Act: 
Established Office of Federal Housing Enterprise Oversight (OFHEO) 
(Federal agency-secondary mortgage markets); 
[Financial Regulatory System now consists of: OCC, FRS, FHLB, FDIC, 
SEC, CFTC, NCUA, OTS, OFHEO] 

1996 – National Securities Markets Improvement Act: Pre-empted most 
state oversight of nationally traded securities; 

1999 – Gramm-Leach-Bliley Act: Eliminated restrictions on banks, 
securities firms, and insurance companies affiliating with each other; 
and reinforced “functional regulation” in which institutions may be 
overseen by multiple regulators; 

2000 – Commodity Futures Modernization Act: Established principles-
based structure for regulating futures exchanges and derivatives 
clearing organizations. Clarified that some off-exchange trading would 
be permitted and remain largely unregulated; 

2002 – Sarbanes-Oxley Act: Established the Public Company Accounting 
Oversight Board (PCAOB) (Federal agency-accounting and auditing); 
[Financial Regulatory System now consists of: OCC, FRS, FHLB, FDIC, 
SEC, CFTC, NCUA, OTS, OFHEO, PCAOB] 

2007-2008 and beyond: 2008 financial crisis; 

2008 – Housing and Economic Recovery Act: Created the Federal Housing 
Finance Agency (FHFA) (Federal agency-secondary mortgage markets); 
Established from FHFB and OFHEO, which were dissolved; 
[Financial Regulatory System now consists of: OCC, FRS, FDIC, SEC, 
CFTC, NCUA, OTS, PCAOB, FHFA] 

Source: GAO. 

[End of figure] 

Overall, responsibilities for overseeing the financial services 
industry are shared among almost a dozen federal banking, securities, 
futures, and other regulatory agencies, numerous self-regulatory 
organizations (SRO), and hundreds of state financial regulatory 
agencies. The following sections describe how regulation evolved in 
various sectors, including banking, securities, thrifts, credit unions, 
futures, insurance, secondary mortgage markets, and other financial 
institutions. The accounting and auditing environment for financial 
institutions, and the role of the Gramm-Leach-Bliley Act in financial 
regulation, are also discussed. 

Banking: 

Since the early days of our nation, banks have allowed citizens to 
store their savings and used these funds to make loans to spur business 
development. Until the middle of the 1800s, banks were chartered by 
states and state regulators supervised their activities, which 
primarily consisted of taking deposits and issuing currency. However, 
the existence of multiple currencies issued by different banks, some of 
which were more highly valued than others, created difficulties for the 
smooth functioning of economic activity. In an effort to finance the 
nation's Civil War debt and reduce financial uncertainty, Congress 
passed the National Bank Act of 1863, which provided for issuance of a 
single national currency. This act also created the Office of the 
Comptroller of the Currency (OCC), which was to oversee the national 
currency and improve banking system efficiency by granting banks 
national charters to operate and conducting oversight to ensure the 
sound operations of these banks. As of 2007, of the more than 16,000 
depository institutions subject to federal regulation in the United 
States, OCC was responsible for chartering, regulating, and supervising 
nearly 1,700 commercial banks with national charters. 

In the years surrounding 1900, the United States experienced troubled 
economic conditions and several financial panics, including various 
instances of bank runs as depositors attempted to withdraw their funds 
from banks whose financial conditions had deteriorated. To improve the 
liquidity of the U.S. banking sector and reduce the potential for such 
panics and runs, Congress passed the Federal Reserve Act of 1913. This 
act created the Federal Reserve System, which consists of the Board of 
Governors of the Federal Reserve System (Federal Reserve), and 12 
Federal Reserve Banks, which are congressionally chartered semiprivate 
entities that undertake a range of actions on behalf of the Federal 
Reserve, including supervision of banks and bank holding companies, and 
lending to troubled banks. The Federal Reserve was given responsibility 
to act as the federal supervisory agency for state-chartered banks-- 
banks authorized to do business under charters issued by states--that 
are members of the Federal Reserve System.[Footnote 6] In addition to 
supervising and regulating bank and financial holding companies and 
nearly 900 state-chartered banks, the Federal Reserve also develops and 
implements national monetary policy, and provides financial services to 
depository institutions, the U.S. government, and foreign official 
institutions, including playing a major role in operating the nation's 
payments system. 

Several significant changes to the U.S. financial regulatory system 
again were made as a result of the turbulent economic conditions in the 
late 1920s and 1930s. In response to numerous bank failures resulting 
in the severe contraction of economic activity of the Great Depression, 
the Banking Act of 1933 created the Federal Deposit Insurance 
Corporation (FDIC), which administers a federal program to insure the 
deposits of participating banks. Subsequently, FDIC's deposit insurance 
authority expanded to include thrifts.[Footnote 7] Additionally, FDIC 
provides primary federal oversight of any insured state-chartered banks 
that are not members of the Federal Reserve System, and it serves as 
the primary federal regulator for over 5,200 state-chartered 
institutions. Finally, FDIC has backup examination and enforcement 
authority over all of the institutions it insures in order to mitigate 
losses to the deposit insurance funds. 

Securities: 

Prior to the 1930s, securities markets were overseen by various state 
securities regulatory bodies and the securities exchanges themselves. 
In the aftermath of the stock market crash of 1929, the Securities 
Exchange Act of 1934 created a new federal agency, the Securities and 
Exchange Commission (SEC) and gave it authority to register and oversee 
securities broker-dealers, as well as securities exchanges, to 
strengthen securities oversight and address inconsistent state 
securities rules.[Footnote 8] In addition to regulation by SEC and 
state agencies, securities markets and the broker-dealers that accept 
and execute customer orders in these markets continue to be regulated 
by SROs, including those of the exchanges and the Financial Industry 
Regulatory Authority, that are funded by the participants in the 
industry. Among other things, these SROs establish rules and conduct 
examinations related to market integrity and investor protection. SEC 
also registers and oversees investment companies and advisers, approves 
rules for the industry, and conducts examinations of broker-dealers and 
mutual funds. State securities regulators--represented by the North 
American Securities Administrators Association--are generally 
responsible for registering certain securities products and, along with 
SEC, investigating securities fraud.[Footnote 9] SEC is also 
responsible for overseeing the financial reporting and disclosures that 
companies issuing securities must make under U.S. securities laws. SEC 
was also authorized to issue and oversee U.S. accounting standards for 
entities subject to its jurisdiction, but has delegated the creation of 
accounting standards to a private-sector organization, the Financial 
Accounting Standards Board, which establishes generally accepted 
accounting principles. 

Thrifts and Credit Unions: 

The economic turmoil of the 1930s also prompted the creation of federal 
regulators for other types of depository institutions, including 
thrifts and credit unions.[Footnote 10] These institutions previously 
had been subject to oversight only by state authorities. However, the 
Home Owners' Loan Act of 1933 empowered the newly created Federal Home 
Loan Bank Board to charter and regulate federal thrifts, and the 
Federal Credit Union Act of 1934 created the Bureau of Federal Credit 
Unions to charter and supervise credit unions.[Footnote 11] Congress 
amended the Federal Credit Union Act in 1970 to establish the National 
Credit Union Administration (NCUA), which is responsible for chartering 
and supervising over 5,000 federally chartered credit unions, as well 
as insuring deposits in these and more than 3,000 state-chartered 
credit unions.[Footnote 12] Oversight of these state-chartered credit 
unions is managed by 47 state regulatory agencies, represented by the 
National Association of State Credit Union Supervisors.[Footnote 13] 

From 1980 to 1990, over 1,000 thrifts failed at a cost of about $100 
billion to the federal deposit insurance funds. In response, the 
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 
abolished the Federal Home Loan Bank Board and, among other things, 
established the Office of Thrift Supervision (OTS) to improve thrift 
oversight.[Footnote 14] OTS charters about 750 federal thrifts and 
oversees these and about 70 state-chartered thrifts, as well as savings 
and loan holding companies[Footnote 15].: 

Futures: 

Oversight of the trading of futures contracts, which allow their 
purchasers to buy or sell a specific quantity of a commodity for 
delivery in the future, has also changed over the years in response to 
changes in the marketplace. Under the Grain Futures Act of 1922, the 
trading of futures contracts was overseen by the Grain Futures 
Administration, an office within the Department of Agriculture, 
reflecting the nature of the products for which futures contracts were 
traded.[Footnote 16] However, futures contracts were later created for 
nonagricultural commodities, such as energy products like oil and 
natural gas, metals such as gold and silver, and financial products 
such as Treasury bonds and foreign currencies. In 1974, a new 
independent federal agency, the Commodity Futures Trading Commission 
(CFTC), was created to oversee the trading of futures contracts. 
[Footnote 17] Like SEC, CFTC relies on SROs, including the futures 
exchanges and the National Futures Association, to establish and 
enforce rules governing member behavior. In 2000, the Commodity Futures 
Modernization Act of 2000 established a principles-based structure for 
the regulation of futures exchanges and derivatives clearing 
organizations, and clarified that some off-exchange derivatives 
trading--and in particular trading on facilities only accessible to 
large, sophisticated traders--was permitted and would be largely 
unregulated or exempt from regulation.[Footnote 18] 

Insurance: 

Unlike most other financial services, insurance activities 
traditionally have been regulated at the state level. In 1944, a U.S. 
Supreme Court decision determined that the insurance industry was 
subject to interstate commerce laws, which could then have allowed for 
federal regulation, but Congress passed the McCarran-Ferguson Act in 
1945 to explicitly return insurance regulation to the states.[Footnote 
19] As a result, as many as 55 state, territorial, or other local 
jurisdiction authorities oversee insurance activities in the United 
States, although state regulations and other activities are often 
coordinated nationally by the National Association of Insurance 
Commissioners (NAIC).[Footnote 20] 

Secondary Mortgage Markets: 

The recent financial crisis in the credit and housing markets has 
prompted the creation of a new, unified federal financial regulatory 
oversight agency, the Federal Housing Finance Agency (FHFA), to oversee 
the government-sponsored enterprises (GSE) Fannie Mae, Freddie Mac, and 
the Federal Home Loan Banks.[Footnote 21] Fannie Mae and Freddie Mac 
are private, federally chartered companies created by Congress to, 
among other things, provide liquidity to home mortgage markets by 
purchasing mortgage loans, thus enabling lenders to make additional 
loans. The system of 12 Federal Home Loan Banks provides funding to 
support housing finance and economic development.[Footnote 22] Until 
enactment of the Housing and Economic Recovery Act of 2008, Fannie Mae 
and Freddie Mac had been overseen since 1992 by the Office of Federal 
Housing Enterprise Oversight (OFHEO), an agency within the Department 
of Housing and Urban Development, and the Federal Home Loan Banks were 
subject to supervision by the Federal Housing Finance Board (FHFB), an 
independent regulatory agency.[Footnote 23] OFHEO regulated Fannie Mae 
and Freddie Mac on matters of safety and soundness, while HUD regulated 
their mission-related activities. FHFB served as the safety and 
soundness and mission regulator of the Federal Home Loan Banks. In July 
2008, the Housing and Economic Recovery Act of 2008 created FHFA to 
establish more effective and more consistent oversight of the three 
housing GSEs--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. 
With respect to Fannie Mae and Freddie Mac, the law gives FHFA such new 
regulatory authorities as the power to regulate the retained mortgage 
portfolios, to set more stringent capital standards, and to place a 
failing entity in receivership. In addition, the law provides FHFA with 
funding outside the annual appropriations process. The law also 
combined the regulatory authorities for all the housing GSEs that were 
previously distributed among OFHEO, FHFB, and the Department of Housing 
and Urban Development. In September 2008, Fannie Mae and Freddie Mac 
were placed in conservatorship, with FHFA serving as the conservator 
under powers provided in the 2008 act. Treasury also created a backstop 
lending facility for the Federal Home Loan Banks, should they decide to 
use it. In November 2008, the Federal Reserve announced plans to 
purchase mortgage-backed securities guaranteed by Fannie Mae and 
Freddie Mac on the open market. 

Gramm-Leach-Bliley: 

Changes in the types of financial activities permitted for depository 
institutions and their affiliates have also shaped the financial 
regulatory system over time. Under the Glass-Steagall provisions of the 
Banking Act of 1933, financial institutions were prohibited from 
simultaneously offering commercial and investment banking services. 
However, in the Gramm-Leach-Bliley Act of 1999 (GLBA), Congress 
permitted financial institutions to fully engage in both types of 
activities and, in addition, provided a regulatory process allowing for 
the approval of new types of financial activity.[Footnote 24] Under 
GLBA, qualifying financial institutions are permitted to engage in 
banking, securities, insurance, and other financial activities. When 
these activities are conducted within the same bank holding company 
structure, they remain subject to regulation by "functional 
regulators," which are the federal authorities having jurisdiction over 
specific financial products or services, such as SEC or CFTC. As a 
result, multiple regulators now oversee different business lines within 
a single institution. For example, broker-dealer activities are 
generally regulated by SEC even if they are conducted within a large 
financial conglomerate that is subject to the Bank Holding Company Act, 
which is administered by the Federal Reserve. The functional regulator 
approach was intended to provide consistency in regulation, focus 
regulatory restrictions on the relevant functional area, and avoid the 
potential need for regulatory agencies to develop expertise in all 
aspects of financial regulation. 

Accounting and Auditing: 

In addition to the creation of various regulators over time, the 
accounting and auditing environment for financial institutions and 
market participants--a key component of financial oversight--has also 
seen substantial change. In the early 2000s, various companies with 
publicly traded securities were found to have issued materially 
misleading financial statements. These companies included Enron and 
WorldCom, both of which filed for bankruptcy. When the actual financial 
conditions of these companies became known, their auditors were called 
into question, and one of the largest, Arthur Andersen, was dissolved 
after the Department of Justice filed criminal charges related to its 
audits of Enron. As a result of these and other corporate financial 
reporting and auditing scandals, the Sarbanes-Oxley Act of 2002 was 
enacted.[Footnote 25] Among other things, Sarbanes-Oxley expanded 
public company reporting and disclosure requirements and established 
new ethical and corporate responsibility requirements for public 
company executives, boards of directors, and independent auditors. The 
act also created a new independent public company audit regulator, the 
Public Company Accounting Oversight Board, to oversee the activities of 
public accounting firms. The activities of this board are, in turn, 
overseen by SEC. 

Other Financial Institutions: 

Some entities that provide financial services are not regulated by any 
of the existing federal financial regulatory bodies. For example, 
entities such as mortgage brokers, automobile finance companies, and 
payday lenders that are not bank subsidiaries or affiliates primarily 
are subject to state oversight, with the Federal Trade Commission 
acting as the primary federal agency responsible for enforcing their 
compliance with federal consumer protection laws. 

Changes in Financial Institutions and Their Products Have Significantly 
Challenged the U.S. Financial Regulatory System: 

Several key developments in financial markets and products in the past 
few decades have significantly challenged the existing financial 
regulatory structure. (See figure 2.) First, the last 30 years have 
seen waves of mergers among financial institutions within and across 
sectors, such that the United States, while still having large numbers 
of financial institutions, also has several very large globally active 
financial conglomerates that engage in a wide range of activities that 
have become increasingly interconnected. Regulating these large 
conglomerates has proven challenging, particularly in overseeing their 
risk management activities on a consolidated basis and in identifying 
and mitigating the systemic risks they pose. A second development has 
been the emergence of large and sometimes less-regulated market 
participants, such as hedge funds and credit rating agencies, which now 
play key roles in our financial markets. Third, the development of new 
and complex products and services has challenged regulators' abilities 
to ensure that institutions are adequately identifying and acting to 
mitigate risks arising from these new activities and that investors and 
consumers are adequately informed of the risks. In light of these 
developments, ensuring that U.S. accounting standards have kept pace 
has also proved difficult, and the impending transition to conform to 
international accounting standards is likely to create additional 
challenges.[Footnote 26] Finally, despite the increasingly global 
aspects of financial markets, the current fragmented U.S. regulatory 
structure has complicated some efforts to coordinate internationally 
with other regulators. 

Figure 2: Key Developments and Resulting Challenges That Have Hindered 
the Effectiveness of the Financial Regulatory System: 

[Refer to PDF for image] 

This figure is an illustration of key developments and resulting 
challenges that have hindered the effectiveness of the Financial 
Regulatory System, as follows: 

Developments in financial markets and products: Financial market size, 
complexity, interactions; Emergence of large, complex, globally active, 
interconnected financial conglomerates; 
Examples of how developments have challenged the regulatory system: 
* Regulators sometimes lack sufficient authority, tools, or 
capabilities to oversee and mitigate risks. 
* Identifying, preventing, mitigating, and resolving systemic crises 
has become more difficult. 

Developments in financial markets and products: Less-regulated entities 
have come to play increasingly critical roles in financial system; 
Examples of how developments have challenged the regulatory system: 
* Nonbank lenders and a new private-label securitization market played 
significant roles in the subprime mortgage crisis that led to broader 
market turmoil. 
* Activities of hedge funds have posed systemic risks. 
* Over reliance on credit ratings of mortgage-backed products 
contributed to the recent turmoil in financial markets. 
* Financial institutions’ use of off-balance sheet entities led to 
ineffective risk disclosure and exacerbated recent market instability. 

Developments in financial markets and products: New and complex 
products that pose challenges to financial stability and investor and 
consumer understanding of risks.
Examples of how developments have challenged the regulatory system: 
* Complex structured finance products have made it difficult for 
institutions and their regulators to manage associated risks. 
* Growth in complex and less-regulated over-the-counter derivatives 
markets have created systemic risks and revealed market infrastructure 
weaknesses. 
* Investors have faced difficulty understanding complex investment 
products, either because they failed to seek out necessary information 
or were misled by improper sales practices. 
* Consumers have faced difficulty understanding mortgages and credit 
cards with new and increasingly complicated features, due in part to 
limitations in consumer disclosures and financial literacy efforts. 
* Accounting and auditing entities have faced challenges in trying to 
ensure that accounting and financial reporting requirements 
appropriately meet the needs of investors and other financial market 
participants. 

Developments in financial markets and products: Financial markets have 
become increasingly global in nature, and regulators have had to 
coordinate their efforts internationally. 
Examples of how developments have challenged the regulatory system: 
* Standard setters and regulators also face new challenges in dealing 
with global convergence of accounting and auditing standards. 
* Fragmented U.S. regulatory structure has complicated some efforts to 
coordinate internationally with other regulators, such as negotiations 
on Basel II and certain insurance matters. 

Sources: GAO (analysis); Art Explosion (images). 

[End of figure] 

Conglomeration and Increased Interconnectedness in Financial Markets 
Have Created Difficulties for a Regulatory System That Lacks a 
Systemwide Focus: 

Overseeing large financial conglomerates that have emerged in recent 
decades has proven challenging, particularly in regulating their 
consolidated risk management practices and in identifying and 
mitigating the systemic risks they pose. These systemically important 
institutions in many cases have tens of thousands or more customers and 
extensive financial linkages with each other through loans, derivatives 
contracts, or trading positions with other financial institutions or 
businesses. The activities of these large financial institutions, as we 
have seen by recent events, can pose significant systemic risks to 
other market participants and the economy as a whole, but the 
regulatory system was not prepared to adequately anticipate and prevent 
such risks. 

Largely as the result of waves of mergers and consolidations, the 
number of financial institutions today has declined. However, the 
remaining institutions are generally larger and more complex, provide 
more and varied services, offer similar products, and operate in 
increasingly global markets. Among the most significant of these 
changes has been the emergence and growth of large financial 
conglomerates or universal banks that offer a wide range of products 
that cut across the traditional financial sectors of banking, 
securities, and insurance. A 2003 IMF study highlighted this emerging 
trend. Based on a worldwide sample of the top 500 financial services 
firms in assets, the study found that the percentage of the largest 
financial institutions in the United States that are conglomerates-- 
financial institutions having substantial operations in more than one 
of the sectors (banking, securities, and insurance)--increased from 42 
percent of the U.S. financial institutions in the sample in 1995 to 62 
percent in 2000.[Footnote 27] This new environment contrasts with that 
of the past in which banks primarily conducted traditional banking 
activities such as deposit taking and lending; securities broker- 
dealers were largely focused on brokerage and underwriting activities; 
and insurance firms offered a more limited set of insurance products. 
In a report that analyzed the regulatory structures of various 
countries, The Group of Thirty noted that the last 25 years have been a 
period of enormous transformation in the financial services sector, 
with a marked shift from firms engaging in distinct banking, 
securities, and insurance businesses to one in which more integrated 
financial services conglomerates offer a broad range of financial 
products across the globe. These fundamental changes in the nature of 
the financial service markets around the world have exposed the 
shortcomings of financial regulatory models, some of which have not 
been adapted to the changes in business structures.[Footnote 28] 

While posing challenges to regulators, these changes have resulted in 
some benefits in the United States financial services industry. For 
example, the ability of financial institutions to offer products of 
varying types increased the options available to consumers for 
investing their savings and preparing for their retirement. 
Conglomeration has also made it more convenient for consumers to 
conduct their financial activities by providing opportunities for one- 
stop shopping for most or all of their needs, and by promoting the 
cross-selling of new innovative products of which consumers may 
otherwise not have been aware. 

However, the rise of large financial conglomerates has also posed risks 
that our current financial regulatory system does not directly address. 
First, although the activities of these large interconnected financial 
institutions often cross traditional sector boundaries, financial 
regulators under the current U.S. regulatory system did not always have 
full authority or sufficient tools and capabilities to adequately 
oversee the risks that these financial institutions posed to themselves 
and other institutions. As we noted in a 2007 report, the activities of 
the Federal Reserve, SEC, and OTS to conduct consolidated supervision 
of many of the largest U.S. financial institutions were not as 
efficient and effective as needed because these agencies were not 
collaborating more systematically.[Footnote 29] In addition, the recent 
market crisis has revealed significant problems with certain aspects of 
these regulators' oversight of financial conglomerates. For example, 
some of the top investment banks were subject to voluntary and limited 
oversight at the holding-company level--the level of the institution 
that generally managed its overall risks--as part of SEC's Consolidated 
Supervised Entity (CSE) Program. SEC's program was created in 2004 as a 
way for global investment bank conglomerates that lack a supervisor 
under law to voluntarily submit to regulation.[Footnote 30] This 
supervision, which could include SEC examinations of the parent 
companies' and affiliates' operations and monitoring of their capital 
levels, enabled the CSEs to qualify for alternative capital rules in 
exchange for consenting to supervision at the holding company level. 
Being subject to consolidated supervision was perceived as necessary 
for these financial institutions to continue operating in Europe under 
changes implemented by the European Union in 2005.[Footnote 31] 

However, according to a September 2008 report by SEC's Inspector 
General, this supervisory program failed to effectively oversee these 
institutions for several reasons, including the lack of an effective 
mechanism for ensuring that these entities maintained sufficient 
capital. In comparison to commercial bank conglomerates, these 
investment banks were holding much less capital in relation to the 
activities exposing them to financial risk. For example, at the end of 
2007, the five largest investment banks had assets to equity capital 
leverage ratios of between 26 and 34 to 1--meaning that for every 
dollar of capital capable of absorbing losses, these institutions held 
between $26 and $34 of assets subject to loss. In contrast, the largest 
commercial bank conglomerates, which were subject to different 
regulatory capital requirements, tended to be significantly less 
leveraged, with the average leverage ratio of the top five largest U.S. 
bank conglomerates at the end of 2007 only about 13 to 1. Moreover, 
because the program SEC used to oversee these investment bank 
conglomerates was voluntary, it had no authority to compel these 
institutions to address any problems that may have been identified. 
Instead, SEC's only means for coercing an institution to take 
corrective actions was to disqualify an institution from CSE status. 
SEC also lacked the ability to provide emergency funding for these 
investment bank conglomerates in a similar way that the Federal Reserve 
could for commercial banks. As a result, these CSE firms, whose 
activities resulted in their being significant and systemically 
important participants with vast interconnections with other financial 
institutions, were more vulnerable to market disruptions that could 
create risks to the overall financial system, but not all were subject 
to full and consistent oversight by a supervisor with adequate 
authority and resources. For example, one of the ways that the 
bankruptcy filing of Lehman Brothers affected other institutions was 
that 25 money market fund advisers had to act to protect their 
investors against losses arising from their investments in that 
company's debt, with at least one of these funds having to be 
liquidated and distributed to its investors. 

[Collapse of the Investment Bank Model: 
Until 2008, the largest U.S. investment banks all generally had similar 
structures that were characterized by a publicly traded holding company 
with a U.S. broker-dealer subsidiary. Each of these firms typically had 
a large number of affiliates, including certain special-purpose U.S.-
regulated banks, banking and securities subsidiaries regulated in 
foreign jurisdictions, and unregulated subsidiaries in the United 
States and abroad, including those used for over-the-counter 
derivatives transactions. Each of these firms was also involved with 
mortgage activities to varying degrees, including originating loans, 
purchasing loans from others, and creating mortgage-backed securities 
sold to investors. However, unlike their commercial bank counterparts 
that had access to large, relatively stable deposit bases to fund part 
of their operations, investment banks were more dependent on short-term 
wholesale funding markets, such as the repurchase or "repo" market that 
involves placing securities (i.e., U.S. Treasury bonds) with another 
party in exchange for cash for a short time and agreeing to buy back 
the securities at the end of that period. As their mortgage-related 
losses increased in the recent turmoil, these institutions encountered 
increasing difficulties in obtaining sufficient funding in these 
wholesale credit markets. Although in March 2008, the Federal Reserve 
extended to the remaining institutions funding that had previously only 
been available to banks, investors' doubts about the viability of these 
investment banks resulted in each of the top five firms either filing 
for bankruptcy, being sold to other institutions, or converting 
themselves into bank or financial holding companies.] 

Following the sale of Bear Stearns to JPMorgan Chase, the Lehman 
bankruptcy filing, and the sale of Merrill Lynch to Bank of America, 
the remaining CSEs opted to become bank holding companies subject to 
Federal Reserve oversight. SEC suspended its CSE program and the 
Chairman stated that "the last six months have made it abundantly clear 
that voluntary regulation does not work."[Footnote 32] 

Recent events have also highlighted difficulties faced by the Federal 
Reserve and OTS in their roles in overseeing risk management at large 
financial and thrift holding companies, respectively. In June 2008 
testimony, a Federal Reserve official acknowledged such supervisory 
lessons, noting that under the current U.S. regulatory structure 
consisting of multiple supervisory agencies, challenges can arise in 
assessing risk profiles of large, complex financial institutions 
operating across financial sectors, particularly given the growth in 
the use of sophisticated financial products that can generate risks 
across various legal entities. He also noted that recent events have 
highlighted the importance of enterprisewide risk management, noting 
that supervisors need to understand risks across a consolidated entity 
and assess the risk management tools being applied across the financial 
institution.[Footnote 33] Our own work had raised concerns over the 
adequacy of supervision of these large financial conglomerates. For 
example, one of the large entities that OTS oversaw was the insurance 
conglomerate AIG, which was subject to a government takeover 
necessitated by financial difficulties the firm experienced as the 
result of OTC derivatives activities related to mortgages. In a 2007 
report, we expressed concerns over the appropriateness of having OTS 
oversee diverse global financial institutions given the size of the 
agency relative to the institutions for which it was responsible. 
[Footnote 34] We had also noted that although OTS oversaw a number of 
holding companies that are primarily in the insurance business, 
including AIG, it had only one specialist in this area as of March 
2007.[Footnote 35] An OTS official noted, however, that functional 
regulation established by Gramm-Leach-Bliley avoided the need for 
regulatory agencies to develop expertise in all aspects of financial 
regulation. 

Second, the emergence of these large institutions with financial 
obligations with thousands of other entities has revealed that the 
existing U.S. regulatory system is not well-equipped for identifying 
and addressing risks across the financial system as a whole. In the 
current environment, with multiple regulators primarily responsible for 
just individual institutions or markets, no one regulator is tasked 
with assessing the risks posed across the entire financial system by a 
few institutions or by the collective activities of the industry. For 
example, multiple factors contributed to the subprime mortgage crisis, 
and many market participants played a role in these events, including 
mortgage brokers, real estate professionals, lenders, borrowers, 
securities underwriters, investors, rating agencies and others. The 
collective activities of these entities, rather than one particular 
institution, likely all contributed to the overall market collapse. In 
particular, the securitization process created incentives throughout 
the chain of participants to emphasize loan volume over loan quality, 
which likely contributed to the problem as lenders sold loans on the 
secondary market, passing risks on to investors. Similarly, once 
financial institutions began to fail and the full extent of the 
financial crisis began to become clear, no formal mechanism existed to 
monitor market trends and potentially stop or help mitigate the fallout 
from these events. Ad hoc actions by the Department of the Treasury, 
the Federal Reserve, other members of the President's Working Group on 
Financial Markets, and FDIC were aimed at helping to mitigate the 
fallout once events began to unfold.[Footnote 36] However, even given 
this ad hoc coordination, our past work has repeatedly identified 
limitations of the current U.S. federal regulatory structure to 
adequately coordinate and share information to monitor risks across 
markets or "functional" areas to identify potential systemic crises. 
[Footnote 37] Whether a greater focus on systemwide risks would have 
fully prevented the recent financial crises is unclear, but it is 
reasonable to conclude that such a mechanism would have had better 
prospects of identifying the breadth of the problem earlier and been 
better positioned to stem or soften the extent of the market fallout. 

Existing Regulatory System Failed to Adequately Address Problems 
Associated with Less-Regulated Entities That Played Significant Roles 
in the U.S. Financial System: 

A second dramatic development in U.S. financial markets in recent 
decades has been the increasingly critical roles played by less- 
regulated entities. In the past, consumers of financial products 
generally dealt with entities such as banks, broker-dealers, and 
insurance companies that were regulated by a federal or state 
regulator. However, in the last few decades, various entities--nonbank 
lenders, hedge funds, credit rating agencies, and special-purpose 
investment entities--that are not always subject to full regulation by 
such authorities have become important participants in our financial 
services markets. These unregulated or less-regulated entities can 
provide substantial benefits by supplying information or allowing 
financial institutions to better meet demands of consumers, investors 
or shareholders but pose challenges to regulators that do not fully or 
cannot oversee their activities. 

Activities of Nonbank Mortgage Lenders Played a Significant Role in 
Mortgage Crisis but Were Not Adequately Addressed by Existing 
Regulatory System: 

The role of nonbank mortgage lenders in the recent financial collapse 
provides an example of a gap in our financial regulatory system 
resulting from activities of institutions that were generally subject 
to little or no direct oversight by federal regulators.[Footnote 38] 
The significant participation by these nonbank lenders in the subprime 
mortgage market--which targeted products with riskier features to 
borrowers with limited or poor credit history--contributed to a 
dramatic loosening in underwriting standards leading up to the crisis. 
In recent years, nonbank lenders came to represent a large share of the 
consumer lending market, including for subprime mortgages. 
Specifically, as shown in figure 3, of the top 25 originators of 
subprime and other nonprime loans in 2006 (which accounted for more 
than 90 percent of the dollar volume of all such originations), all but 
4 were nonbank lenders, accounting for 81 percent of origination by 
dollar volume.[Footnote 39] 

Figure 3: Status of Top 25 Subprime and Nonprime Mortgage Lenders 
(2006): 

[Refer to PDF for image] 

This figure contains two pie-charts depicting the following data: 

Status of Top 25 Subprime and Nonprime Mortgage Lenders (2006): 

Number of lenders: 
84%: 21 nonbanks: (56%: 14 independent lenders; 28%: 7 subsidiaries); 
16%: 4 Banks; 
Total: 25 lenders. 

Loan origination volume, 2006 (dollars in billions): 
81%: $441 billion (nonbanks) (44%- $239 billion: independent lenders; 
37%- $203 billion: subsidiaries; 
19%: $102 billion (banks); 
Total: $543 billion. 

Source: GAO. 

[End of figure] 

Although these lenders were subject to certain federal consumer 
protection and fair lending laws, they were generally not subject to 
the same routine monitoring and oversight by federal agencies that 
their bank counterparts were. From 2003 to 2006, subprime lending grew 
from about 9 percent to 24 percent of mortgage originations (excluding 
home equity loans), and Alt-A lending (nonprime loans considered less 
risky than subprime) grew from about 2 percent to almost 16 percent, 
according to data from the trade publication Inside Mortgage Finance. 
The resulting sharp rise in defaults and foreclosures that occurred as 
subprime and other homeowners were unable to make mortgage payments led 
to the collapse of the subprime mortgage market and set off a series of 
events that led to today's financial turmoil. 

In previous reports, we noted concerns that existed about some of these 
less-regulated nonbank lenders and recommended that federal regulators 
actively monitor their activities.[Footnote 40] For example, in a 2004 
report, we reported that some of these nonbank lenders had been the 
targets of notable federal and state enforcement actions involving 
abusive lending. As a result, we recommended to Congress that the 
Federal Reserve should be given a greater role in monitoring the 
activities of some nonbank mortgage lenders that are subsidiaries of 
bank holding companies that the Federal Reserve regulates. Only 
recently, in the wake of the subprime mortgage crisis, the Federal 
Reserve began a pilot program in conjunction with OTS and the 
Conference of State Bank Supervisors to monitor the activities of 
nonbank subsidiaries of holding companies, with the states conducting 
examinations of independent state-licensed lenders. Nevertheless, other 
nonbank lenders continue to operate under less rigorous federal 
oversight and remain an example of the risks posed by less-regulated 
institutions in our financial regulatory system. 

The increased role in recent years of investment banks securitizing and 
selling mortgage loans to investors further illustrates gaps in the 
regulatory system resulting from less-regulated institutions. Until 
recently, GSEs Fannie Mae and Freddie Mac were responsible for the vast 
majority of mortgage loan securitization. The securitization of loans 
that did not meet the GSEs' congressionally imposed loan limits or 
regulator-approved quality standards--such as jumbo loans that exceeded 
maximum loan limits and subprime loans--was undertaken by investment 
firms that were subject to little or no standards to ensure safe and 
sound practices in connection with the purchase or securitization of 
loans. As the volume of subprime lending grew dramatically from around 
2003 through 2006, investment firms took over the substantial share of 
the mortgage securitization market. As shown in figure 4, this channel 
of mortgage funding--known as the private label mortgage-backed 
securities market--grew rapidly and in 2005 surpassed the combined 
market share of the GSEs and Ginnie Mae--a government corporation that 
guarantees mortgage-backed securities. As the volume of subprime loans 
increased, a rapidly growing share was packaged into private label 
securities, reaching 75 percent in 2006, according to the Federal 
Reserve Bank of San Francisco. 

Figure 4: Growth in Proportion of Private Label Securitization in the 
Mortgage-Backed Securities Market, in Dollars and Percentage of Dollar 
Volume (1995-2007): 

[Refer to PDF for image] 

This figure contains two multiple line graphs depicting the following 
data: 

Volume of RMBS issuance: 

Year: 1995; 
Private label: $48.926 billion; 	
Ginnie Mae/GSE: $269.096 billion. 

Year: 1996; 	
Private label: $69.893 billion; 
Ginnie Mae/GSE: $370.431 billion. 

Year: 1997; 	
Private label: $119.132 billion; 
Ginnie Mae/GSE: $367.700 billion. 

Year: 1998; 
Private label: $203.211 billion; 
Ginnie Mae/GSE: $726.024 billion. 

Year: 1999; 
Private label: $147.899 billion; 
Ginnie Mae/GSE: $685.130 billion. 

Year: 2000; 	
Private label: $135.959 billion; 
Ginnie Mae/GSE: $479.080 billion. 

Year: 2001; 	
Private label: $267.320 billion; 
Ginnie Mae/GSE: $1,087.645 billion. 

Year: 2002; 	
Private label: $413.955 billion; 
Ginnie Mae/GSE: $1,442.570 billion. 

Year: 2003; 	
Private label: $586.216 billion; 
Ginnie Mae/GSE: $2,130.917 billion. 

Year: 2004; 	
Private label: $864.152 billion; 
Ginnie Mae/GSE: $1,018.684 billion. 

Year: 2005; 	
Private label: $1,191.263 billion; 
Ginnie Mae/GSE: $964.697 billion. 

Year: 2006; 
Private label: $1,145.612 billion; 
Ginnie Mae/GSE: $904.547 billion. 

Year: 2007; 	
Private label: $642.700 billion; 
Ginnie Mae/GSE: $1,159.400 billion. 

Share of RMBS issuance: 

Year: 1995%; 
Ginnie Mae/GSE: 84.62%; 
Private label: 15.38%. 

Year: 1996%; 
Ginnie Mae/GSE: 84.13%; 
Private label: 15.87%. 

Year: 1997%; 
Ginnie Mae/GSE: 75.53%; 
Private label: 24.47%. 

Year: 1998%; 
Ginnie Mae/GSE: 78.13%; 
Private label: 21.87%. 

Year: 1999%; 
Ginnie Mae/GSE: 82.25%; 
Private label: 17.75%. 

Year: 2000%; 
Ginnie Mae/GSE: 77.89%; 
Private label: 22.11%. 

Year: 2001%; 
Ginnie Mae/GSE: 80.27%; 
Private label: 19.73%. 

Year: 2002%; 
Ginnie Mae/GSE: 77.69%; 
Private label: 22.29%. 

Year: 2003%; 
Ginnie Mae/GSE: 78.43%; 
Private label: 21.57%. 

Year: 2004%; 
Ginnie Mae/GSE: 54.1%; 
Private label: 45.9%. 

Year: 2005%; 
Ginnie Mae/GSE: 44.75%; 
Private label: 55.25%. 

Year: 2006%; 
Ginnie Mae/GSE: 44.12%; 
Private label: 55.88%. 

Year: 2007%; 
Ginnie Mae/GSE: 64.34%; 
Private label: 35.66%. 

Source: GAO analysis of data from Inside Mortgage Finance. 

[End of figure] 

As shown in figure 4, this growth allowed private label securities to 
become approximately 55 percent of all mortgage-backed security 
issuance by 2005. This development serves as yet another example of how 
a less-regulated part of the market, private label securitization, 
played a significant role in fostering risky subprime mortgage lending, 
exposing a gap in the financial regulatory structure. 

The role of mortgage brokers in the sale of mortgage products in recent 
years has also been a key focus of attention of policymakers. In past 
work, we noted that the role of mortgage brokers grew in the years 
leading up to the current crisis. By one estimate, the number of 
brokerages rose from about 30,000 firms in 2000 to 53,000 firms in 
2004. In 2005, brokers accounted for about 60 percent of originations 
in the subprime market (compared with about 25 percent in the prime 
market).[Footnote 41] In 2008, in the wake of the subprime mortgage 
crisis, Congress enacted the Secure and Fair Enforcement for Mortgage 
Licensing Act, as part of the Housing and Economic Recovery Act, to 
require enhanced licensing and registration of mortgage brokers. 
[Footnote 42] 

Activities of Hedge Funds Can Pose Systemic Risks Not Recognized by 
Regulatory System: 

Hedge funds, which are professionally managed investment funds for 
institutional and wealthy investors, have become significant 
participants in many important financial markets. For example, hedge 
funds often assume risks that other more regulated institutions are 
unwilling or unable to assume, and therefore generally are recognized 
as benefiting markets by enhancing liquidity, promoting market 
efficiency, spurring financial innovation, and helping to reallocate 
financial risk. But hedge funds receive less-direct oversight than 
other major market participants such as mutual funds, another type of 
investment fund that manages pools of assets on behalf of investors. 
[Footnote 43] Hedge funds generally are structured and operated in a 
manner that enables them to qualify for exemptions from certain federal 
securities laws and regulations.[Footnote 44] Because their 
participants are presumed to be sophisticated and therefore not require 
the full protection offered by the securities laws, hedge funds have 
not generally been subject to direct regulation. Therefore, hedge funds 
are not subject to regulatory capital requirements, are not restricted 
by regulation in their choice of investment strategies, and are not 
limited by regulation in their use of leverage. By soliciting 
participation in their funds from only certain large institutions and 
wealthy individuals and refraining from advertising to the general 
public, hedge funds are not required to meet the registration and 
disclosure requirements of the Securities Act of 1933 or the Securities 
Exchange Act of 1934, such as providing their investors with detailed 
prospectuses on the activities that their fund will undertake using 
investors' proceeds.[Footnote 45] Hedge fund managers that trade on 
futures exchanges and that have U.S. investors are required to register 
with CFTC and are subject to periodic reporting, recordkeeping, and 
disclosure requirements of their futures activities, unless they notify 
the Commission that they qualify for an exemption from registration. 
[Footnote 46] 

The activities of many, but not all, hedge funds have recently become 
subject to greater oversight from SEC, although the rule requiring 
certain hedge fund advisers to register as investment advisers was 
recently vacated by a federal appeals court. In December 2004, SEC 
amended its rules to require certain hedge fund advisers that had been 
exempt from registering with SEC as investment advisers under its 
"private adviser" exemption to register as investment advisers. 
[Footnote 47] In August 2006, SEC estimated that over 2,500 hedge fund 
advisers were registered with the agency, although what percentage of 
all hedge fund advisers active in the United States that this 
represents is not known. Registered hedge fund advisers are subject to 
the same requirements as all other registered investment advisers, 
including providing current information to both SEC and investors about 
their business practices and disciplinary history, maintaining required 
books and records, and being subject to periodic SEC examinations. Some 
questions exist over the extent of SEC's authority over these funds. In 
June 2006, the U.S. Court of Appeals for the District of Columbia 
overturned SEC's amended rule, concluding that the rule was arbitrary 
because it departed, without reasonable justification, from SEC's long-
standing interpretation of the term "client" in the private adviser 
exemption as referring to the hedge fund itself, and not to the 
individual investors in the fund.[Footnote 48] However, according to 
SEC, most hedge fund advisers that previously registered have chosen to 
retain their registered status as of April 2007. 

Although many hedge fund advisers are now subject to some SEC 
oversight, some financial regulators and market participants remain 
concerned that hedge funds' activities can create systemic risk by 
threatening the soundness of other regulated entities and asset 
markets. Hedge funds have important connections to the financial 
markets, including significant business relationships with the largest 
regulated commercial banks and broker-dealers. They act as trading 
counterparties with many of these institutions and constitute in many 
markets a significant portion of trading activity, from stocks to 
distressed debt and credit derivatives.[Footnote 49] 

The far-reaching consequences of potential hedge fund failures first 
became apparent in 1998. The hedge fund Long Term Capital Management 
(LTCM) experienced large losses related to the considerable positions-
-estimated to be as large as $100 billion--it had taken in various 
sovereign debt and other markets, and regulators coordinated with 
market participants to prevent a disorderly collapse that could have 
led to financial problems among LTCM's lenders and counterparties and 
potentially to the rest of the financial system.[Footnote 50] No 
taxpayer funds were used as part of this effort; instead, the various 
large financial institutions with large exposures to this hedge fund 
agreed to provide additional funding of $3.6 billion until the fund 
could be dissolved in an orderly way. Since LTCM, other hedge funds 
have experienced near collapses or failures, including two funds owned 
by Bear Stearns, but these events have not had as significant impact on 
the broader financial markets as LTCM. 

Also, since LTCM's near collapse, investors, creditors, and 
counterparties have increased their efforts to impose market discipline 
on hedge funds. According to regulators and market participants, 
creditors and counterparties have been conducting more extensive due 
diligence and monitoring risk exposures to their hedge fund clients. In 
addition, hedge fund advisers have improved disclosure and become more 
transparent about their operations, including their risk-management 
practices. However, we reported in 2008 that some regulators continue 
to be concerned that the counterparty credit risk created when 
regulated financial institutions transact with hedge funds can be a 
primary channel for potentially creating systemic risk.[Footnote 51] 

Credit Rating Agency Activities Also Illustrate the Failure of the 
Regulatory System to Address Risks Posed by Less-Regulated Entities: 

Similar to hedge funds, credit rating agencies have come to play a 
critical role in financial markets, but until recently they received 
little regulatory oversight. While not acting as direct participants in 
financial markets, credit ratings are widely used by investors for 
distinguishing the creditworthiness of bonds and other securities. 
Additionally, credit ratings are used in local, federal, and 
international laws and regulations as a benchmark for permissible 
investments by banks, pension funds, and other institutional investors. 
Leading up to the recent crisis, some investors had come to rely 
heavily on ratings in lieu of conducting independent assessments on the 
quality of assets. This overreliance on credit ratings of subprime 
mortgage-backed securities and other structured credit products 
contributed to the recent turmoil in financial markets. As these 
securities started to incur losses, it became clear that their ratings 
did not adequately reflect the risk that these products ultimately 
posed. According to the trade publication Inside B&C Lending, the three 
major credit rating agencies have each downgraded more than half of the 
subprime mortgage-backed securities they originally rated between 2005 
and 2007. 

However, despite the critical nature of these rating agencies in our 
financial system, the existing regulatory system failed to adequately 
foresee and manage their role in recent events. Until recently, credit 
rating agencies received little direct oversight and thus faced no 
explicit requirements to provide information to investors about how to 
understand and appropriately use ratings, or to provide data on the 
accuracy of their ratings over time that would allow investors to 
assess their quality. In addition, concerns have been raised over 
whether the way in which credit rating agencies are compensated by the 
issuers of the securities that they rate affects the quality of the 
ratings awarded. In a July 2008 report, SEC noted multiple weaknesses 
in the management of these conflicts of interest, including instances 
where analysts expressed concerns over fees and other business 
interests when issuing ratings and reviewing ratings criteria.[Footnote 
52] However, until 2006, no legislation had established statutory 
regulatory authority or disclosure requirements over credit rating 
agencies.[Footnote 53] Then, to improve the quality of ratings in 
response to events such as the failures of Enron and Worldcom--which 
highlighted the limitations of credit ratings in identifying companies' 
financial strength--Congress passed the Credit Rating Agency Reform Act 
of 2006, which established limited SEC oversight, requiring their 
registration and certain recordkeeping and reporting requirements. 
[Footnote 54] 

Since the financial crisis began, regulators have taken steps to 
address the important role of rating agencies in the financial system. 
In December 2008, in response to the subprime mortgage crisis and 
resulting credit market strains, SEC adopted final rule amendments and 
proposed new rule amendments that would impose additional requirements 
on nationally recognized statistical rating organizations in order to 
address concerns raised about the policies and procedures for, 
transparency of, and potential conflicts of interest relating to 
ratings. Determining the most appropriate government role in overseeing 
credit rating activities is difficult. For example, SEC has expressed 
concerns that too much government intervention--such as regulatory 
requirements of credit ratings for certain investments or examining the 
underlying methodology of ratings--would unintentionally provide an 
unofficial "seal of approval" on the ratings and therefore be 
counterproductive to reducing overreliance on ratings. Whatever the 
solution, it is clear that the current regulatory system did not 
properly recognize and address the risks associated with the important 
role these entities played. 

Regulatory System Failed to Identify Risks Associated with Special- 
Purpose Entities: 

The use by financial institutions of special-purpose entities provides 
another example of how less-regulated aspects of financial markets came 
to play increasingly important roles in recent years, creating 
challenges for regulators in overseeing risks at their regulated 
institutions. Many financial institutions created and transferred 
assets to these entities as part of securitizations for mortgages or to 
hold other assets and produce fee income for the institution that 
created it--known as the sponsor. For example, after new capital 
requirements were adopted in the late 1980s, some large banks began 
creating these entities to hold assets for which they would have been 
required to hold more capital against if the assets were held within 
their institutions. As a result, these entities are also known as off- 
balance sheet entities because they generally are structured in such a 
way that their assets and liabilities are not required to be 
consolidated and reported as part of the overall balance sheet of the 
sponsoring financial institution that created them. The amount of 
assets accumulated in these entities resulted in them becoming 
significant market participants in the last few years. For example, one 
large commercial bank reported that its off-balance sheet entities 
totaled more than $1 trillion in assets at the end of 2007. 

Some of these off-balance sheet entities were structured in a way that 
left them vulnerable to market disruptions. For example, some financial 
institutions created entities known as asset-backed commercial paper 
conduits that would purchase various assets, including mortgage-related 
securities, financial institution debt, and receivables from industrial 
businesses. To obtain the funds to purchase these assets, these special-
purpose vehicles often borrowed using shorter-term instruments, such as 
commercial paper and medium-term notes. The difference between the 
interest paid to the commercial paper or note holders and the income 
earned on the entity's assets produced fee and other income for the 
sponsoring institution. However, these structures carried the risk that 
the entity would find it difficult or costly to renew its debt 
financing under less-favorable market conditions. 

Although structured as off-balance sheet entities, when the turmoil in 
the markets began in 2007, many financial institutions that had created 
these entities had to take back the loans and securities in certain 
types of these off-balance sheet entities. (See figure 5) 

[Credit Ratings and the Financial Crisis: 
Traditionally, products receiving the highest credit ratings, such as 
AAA, were a small set of corporate and sovereign bonds that were deemed 
to be the safest and most stable debt investments. However, credit 
rating agencies assigned similarly high credit ratings to many of the 
newer mortgage-related products even though these products did not have 
the same characteristics as previously highly rated securities. As a 
result of these ratings, institutions were able to successfully market 
many of these products, including to other financial firms and 
institutional investors in the United States and around the world. 
Ratings were seen to provide a common measure of credit risk across all 
debt products, allowing structured credit products that lacked an 
active secondary market to be valued against similarly rated products 
with available prices. Starting in mid-2007, increasing defaults on 
residential mortgages, particularly those for subprime borrowers, led 
to a widespread, rapid, and severe series of downgrades by rating 
agencies on subprime-related structured credit products. These 
downgrades undermined confidence in the quality of ratings on these and 
related products. Along with increasing defaults, the uncertainty over 
credit ratings led to a sharp repricing of assets across the financial 
system and contributed to large writedowns in the market value of 
assets by banks and other financial institutions. This contributed to 
the unwilling-ness of many market participants to transact with each 
other due to concerns over the actual value of assets and the financial 
condition of other financial institutions.] 

Figure 5: Example of an Off-Balance Sheet Entity: 

[Refer to PDF for image] 

This figure is an illustration of an Off-Balance Sheet Entity, as 
follows: 

Before financial turmoil: Bank balance sheet:
* Assets A; 
* Assets B: Bank arranged for assets to be held in a Special Purpose 
Entity (SPE). In doing so, the assets were no longer reflected on the 
bank’s balance sheet and the bank could hold less capital. Assets B 
sent to SPE. 

Special Purpose Entity (SPE): The SPE issued debt to investors; 
The assumption that the assets posed no harm to the bank and did not 
need to be reflected on the bank’s balance sheet proved untrue. Some 
banks had entered emergency financing commitments that were instituted 
when the financial turmoil began, forcing them to fund the SPE and 
reflect its assets back on the bank balance sheet. In other cases, 
sponsors of different SPEs financed them directly to protect their 
reputations with clients. Assets B returned to bank. 

After financial turmoil: Bank balance sheet:
* Assets A; 
* Assets B. 

Source: GAO. 

[End of figure] 

In general, banks stepped in to finance the assets held by these 
entities when they were unable to refinance their expiring debt due to 
market concerns over the quality of the assets. In some cases, off- 
balance sheet entities relied on emergency financing commitments that 
many sponsoring banks had extended to these entities. In other cases, 
financial institutions supported troubled off-balance sheet entities to 
protect their reputations with clients even when no explicit 
requirement to do so existed. This, in turn, contributed to the 
reluctance of banks to lend as they had to fund additional troubled 
assets on their balance sheets. Thus, although the use of these 
entities seemingly had removed the risk of these assets from these 
institutions, their inability to obtain financing resulted in the 
ownership, risks, and losses of these entities' assets coming back into 
many of the sponsoring financial institutions. 

According to a 2008 IMF study, financial institutions' use of off- 
balance sheet entities made it difficult for regulators, as well as 
investors, to fully understand the associated risks of such activities. 
In response to these developments, regulators and others have begun to 
reassess the appropriateness of the regulatory and accounting treatment 
for these entities. In January 2008, SEC asked the Financial Accounting 
Standards Board (FASB), which establishes U.S. financial accounting and 
reporting standards, to consider further improvements to the accounting 
and disclosure for off-balance sheet transactions involving 
securitization. FASB and the International Accounting Standards Board 
both have initiated projects to improve the criteria for determining 
when financial assets and related liabilities that institutions 
transfer to special-purpose entities should be included on the 
institutions' own balance sheets--known as consolidation--and to 
enhance related disclosures. As part of this effort, FASB issued 
proposed standards that would eliminate a widely used accounting 
exception for off-balance sheet entities, introduce a new accounting 
model for determining whether special-purpose entities should be 
consolidated that is less reliant on mathematical calculations and more 
closely aligned with international standards, and require additional 
disclosures about institutions' involvement with certain special- 
purpose entities. On December 18, 2008, the International Accounting 
Standards Board also issued a proposed standard on consolidation of 
special-purpose entities and related risk disclosures. In addition, in 
April 2008, the Basel Committee on Banking Supervision announced new 
measures to capture off-balance sheet exposures more effectively. 

Nevertheless, this serves as another example of the failure of the 
existing regulatory system to recognize the problems with less- 
regulated entities and take steps to address them before they escalate. 
Existing accounting and disclosure standards had not required banks to 
extensively disclose their holdings in off-balance sheet entities and 
allowed for very low capital requirements. As a March 2008 study by the 
President's Working Group on Financial Markets noted, before the recent 
market turmoil, supervisory authorities did not insist on appropriate 
disclosures of firms' potential exposure to off-balance sheet entities. 

New and Complex Financial Products and Services Also Revealed 
Limitations in the Regulatory Structure: 

Another development that has revealed limitations in the current 
regulatory structure has been the proliferation of more complex 
financial products. Although posing challenges, these new products also 
have provided certain benefits to financial markets and consumers. For 
example, the creation of securitized products such as mortgage-backed 
securities increased the liquidity of credit markets by providing 
additional funds to lenders and a wider range of investment returns to 
investors with excess funds. Other useful product innovations included 
OTC derivatives, such as currency options, which provide a purchaser 
the right to buy a specified quantity of a currency at some future 
date, and interest rate swaps, which allow one party to exchange a 
stream of fixed interest rate payments for a stream of variable 
interest rate payments. These products help market participants hedge 
their risks or stabilize their cash flows. Alternative mortgage 
products, such as interest-only loans, originally were used by a 
limited subset of the population, mainly wealthy borrowers, to obtain 
more convenient financing for home purchases. Despite these advantages, 
the complexity and expanded use of new products has made it difficult 
for the current regulatory system to oversee risk management at 
institutions and adequately protect individual consumers and investors. 

New Complex Securitized Products Have Created Difficulties for 
Institutions and Regulators in Valuing and Assessing Their Risks: 

Collateralized debt obligations (CDO) are one of the new products that 
proliferated and created challenges for financial institutions and 
regulators. In a basic CDO, a group of loans or debt securities are 
pooled and securities are then issued in different tranches that vary 
in risk and return depending on how the underlying cash flows produced 
by the pooled assets are allocated. If some of the underlying assets 
defaulted, the more junior tranches--and thus riskier ones--would 
absorb these losses first before the more senior, less-risky tranches. 
Purchasers of these CDO securities included insurance companies, mutual 
funds, commercial and investment banks, and pension funds. Many CDOs in 
recent years largely consisted of mortgage-backed securities, including 
subprime mortgage-backed securities. 

Although CDOs have existed since the 1980s, recent changes in the 
underlying asset mix of these products led to increased risk that was 
poorly understood by the financial institutions involved in these 
investments. CDOs had consisted of simple securities like corporate 
bonds or loans, but more recently have included subprime mortgage- 
backed securities, and in some cases even lower-rated classes of other 
equally complex CDOs. Some of these CDOs included investments in 100 or 
more asset-backed securities, each of which had its own large pool of 
loans and specific payment structures.[Footnote 55] A large share of 
the total value of the securities issued were rated AA or AAA-- 
designating them as very safe investments and unlikely to default--by 
the credit rating agencies. In part because of their seemingly high 
returns in light of their rated risk, demand for these new CDOs grew 
rapidly and on a large scale. Between 2004 and 2007, nearly all 
adjustable-rate subprime mortgages were packaged into mortgage-backed 
securities, a large portion of which were structured into CDOs. 

As housing prices in the United States softened in the last 2 years, 
default and foreclosure rates on the mortgages underlying many CDOs 
rose and the credit rating agencies downgraded many CDO ratings, 
causing investors to become unwilling to purchase these products in the 
same quantities or at the prices previously paid. Many financial 
institutions, including large commercial and investment banks, 
struggled to realize the size of their exposure to subprime credit 
risk. Many of these institutions appeared to have underestimated the 
amount of risk and potential losses that they could face from creating 
and investing in these products. Reductions in the value of subprime- 
backed CDOs have contributed to reported losses by financial 
institutions totaling more than $750 billion globally, as of September 
2008, according to the International Monetary Fund, which estimates 
that total losses on global holdings of U.S. loans and securities could 
reach $1.4 trillion. 

Several factors could explain why institutions--and regulators--did not 
effectively monitor and limit the risk that CDOs represented. Products 
like CDOs have risk characteristics that differ from traditional 
investments. First, the variation and complexity of the CDO structures 
and the underlying assets they contain often make estimating potential 
losses and determining accurate values for these products more 
difficult than for traditional securities. Second, although aggregating 
multiple assets into these structures can diversify and thus reduce the 
overall risk of the securities issued from them, their exposure to the 
overall housing market downturn made investors reluctant to purchase 
even the safest tranches, which produced large valuation losses for the 
holders of even the highest-rated CDO securities.[Footnote 56] Finally, 
Federal Reserve staff noted that an additional reason these securities 
performed worse than expected was that rating agencies and investors 
did not believe that housing prices could have fallen as significantly 
as they have. 

The lack of historical performance data for these new instruments also 
presented challenges in estimating the potential value of these 
securities. For example, the Senior Supervisors Group--a body 
comprising senior financial supervisors from France, Germany, 
Switzerland, the United Kingdom, and the United States--reported that 
some financial institutions substituted price and other data associated 
with traditional corporate debt in their loss estimation models for 
similarly rated CDO debt, which did not have sufficient historical 
data.[Footnote 57] As a report by a group of senior representatives of 
financial regulators and institutions has noted, the absence of 
historical information on the performance of CDOs created uncertainty 
around the standard risk-management tools used by financial 
institutions.[Footnote 58] Further, structured products such as CDOs 
may lack an active and liquid market, as in the recent period of market 
stress, forcing participants to look for other sources of valuation 
information when market prices are not readily available. For instance, 
market participants often turned to internal models and other methods 
to value these products, which raised concerns about the consistency 
and accuracy of the resulting valuation information. 

Growth in OTC Derivatives Markets, Which Feature Complex Products That 
Are Not Regulated, Raised Regulator Concerns about Systemic Risk and 
Weak Market Infrastructure: 

The rapid growth in OTC derivatives--or derivatives contracts that are 
traded outside of regulated exchanges--is another example of how the 
emergence of large markets for increasingly complex products has 
challenged our financial regulatory system. OTC derivatives, which 
began trading in the 1980s, have developed into markets with an 
estimated notional value--which is the amount underlying a financial 
derivatives contract--of about $596 trillion, as of December 2007, 
according to the Bank for International Settlements.[Footnote 59] OTC 
derivatives transactions are generally not subject to regulation by 
SEC, CFTC, or any other U.S. financial regulator and in particular are 
not subject to similar disclosure and other requirements that are in 
place for most securities and exchange-traded futures products. 
Institutions that conduct derivatives transactions may be subject to 
oversight of their lines of business by their regulators. For example, 
commercial banks that deal in OTC derivatives are subject to full 
examinations by their respective regulators. On the other hand, 
investment banks generally conducted their OTC derivatives activities 
in affiliates or subsidiaries that traditionally--since most OTC 
derivatives are not securities--were not subject to direct oversight by 
SEC, although SEC did review how the largest investment banks that were 
subject to its CSE program were managing the risk of such activities. 

Although OTC derivatives and their markets are not directly regulated, 
the risk exposures that these products created among regulated 
financial institutions can be sometimes large enough to raise systemic 
risk concerns among regulators. For example, Bear Stearns, the 
investment bank that experienced financial difficulties as the result 
of its mortgage-backed securities activities, was also one of the 
largest OTC derivatives dealers. According to regulators, one of the 
primary reasons the Federal Reserve, which otherwise had no regulatory 
authority over this securities firm, facilitated the sale of Bear 
Stearns rather than let it go bankrupt was to avoid a potentially large 
systemic problem because of the firm's large OTC derivatives 
obligations. More than a decade ago, we reported that the large 
financial interconnections between derivatives dealers posed risk to 
the financial system and recommended that Congress and financial 
regulators take action to ensure that the largest firms participating 
in the OTC derivatives markets be subject to similar regulatory 
oversight and requirements.[Footnote 60] 

The market for one type of OTC derivative--credit default swaps--had 
grown so large that regulators became concerned about its potential to 
create systemic risks to regulated financial institutions. Credit 
default swaps are contracts that act as a type of insurance, or a way 
to hedge risks, against default or another type of credit event 
associated with a security such as a corporate bond. One party in the 
contract--the seller of protection--agrees, in return for a periodic 
fee, to compensate the other party--the protection buyer--if the bond 
or other underlying entity defaults or another specified credit event 
occurs. In recent years, the size of the market for credit default 
swaps (in terms of the notional amount of outstanding contracts) has 
increased almost tenfold from just over $6 trillion in 2004 to almost 
$58 trillion at the end of 2007, according to the Bank for 
International Settlements. 

As this market has grown, regulators increasingly have become concerned 
about the adequacy of the infrastructure in place for clearing and 
settling these contracts, especially the ability to quickly resolve 
contracts in the event of a large market participant failure. For 
example, in September 2008, concerns over the effects that a potential 
bankruptcy of AIG--which was a large seller of credit default swaps-- 
would have on this firm's swap counterparties contributed to a decision 
by the Federal Reserve to lend the firm up to $85 billion.[Footnote 61] 
The Federal Reserve expressed concern at the time that a disorderly 
failure of AIG could add to already significant levels of financial 
market fragility and lead to substantially higher borrowing costs, 
reduced household wealth, and materially weaker economic performance. 
As with other OTC derivatives, credit default swaps are not regulated 
as products, but many of the large U.S. and internationally regulated 
financial institutions act as dealers. Despite the credit default 
market's rapid growth, as recently as 2005 the processing of 
transactions was still paper-based and decentralized. Regulators have 
put forth efforts over the years to strengthen clearing and settlement 
mechanisms. For example, in September 2005, the Federal Reserve Bank of 
New York began working with dealers and market participants to 
strengthen arrangements for clearing and settling these swap 
transactions. Regulators began focusing on reducing a large backlog of 
unconfirmed trades, which can inhibit market participants' ability to 
manage their risks if errors are not found quickly or if uncertainty 
exists about how other institutions would be affected by the failure of 
a firm with which they hold credit default swap contracts. Regulators 
continue to monitor dealers' progress on these efforts to reduce 
operational risk arising from these products, and recently have begun 
holding discussions with the largest credit derivatives dealers and 
other entities, including certain exchanges, regarding the need to 
establish a centralized clearing facility, which could reduce the risk 
of any one dealer's failure to the overall system. In November 2008, 
the President's Working Group on Financial Markets announced policy 
objectives to guide efforts to address challenges associated with OTC 
derivatives, including recommendations to enhance the market 
infrastructure for credit default swaps. However, as of December 2008, 
no such entity had begun operations. 

New Complex Products Have Also Created Challenges for Regulators in 
Ensuring Adequate Investor and Consumer Protection: 

The regulations requiring that investors receive adequate information 
about the risks of financial assets being marketed to them are also 
being challenged by the development of some of these new and complex 
products. For some of the new products that have been created, market 
participants sometimes had difficulty obtaining clear and accurate 
information on the value of these assets, their risks, and other key 
information. In some cases, investors did not perform needed due 
diligence to fully understand the risks associated with their 
investment. In other cases, investors have claimed they were misled by 
broker-dealers about the advantages and disadvantages of products. For 
example, investors for municipal governments in Australia have accused 
Lehman Brothers of misleading them regarding the risks of CDOs. As 
another example, the treasurer of Orange County who oversaw investments 
leading to the county's 1994 bankruptcy claimed to have relied on the 
advice of a large securities firm for his decision to pursue leveraged 
investments in complex structured products. Finally, a number of 
financial institutions--including Bank of America, Wachovia, Merrill 
Lynch, and UBS--have recently settled SEC allegations that these 
institutions misled investors in selling auction-rate securities, which 
are bonds for which the interest rates are regularly reset through 
auctions. In one case, Bank of America, in October 2008, reached a 
settlement in principle in response to SEC charges that it made 
misrepresentations to thousands of businesses, charities, and 
institutional investors when it told them that the products were safe 
and highly liquid cash and money market alternative investments. 

Similarly, the introduction and expansion of increasingly complicated 
retail products to new and broader consumer populations has also raised 
challenges for regulators in ensuring that consumers are adequately 
protected. Consumers face growing difficulty in understanding the 
relative advantages and disadvantages of products such as mortgages and 
credit cards with new and increasingly complicated features, in part 
because of limitations on the part of regulatory agencies to improve 
consumer disclosures and financial literacy. For example, in the last 
few years many borrowers likely did not understand the risks associated 
with taking out their loans, especially in the event that housing 
prices would not continue to increase at the rate at which they had 
been in recent years. In particular, a significant majority of subprime 
borrowers from 2003 to 2006 took out adjustable-rate mortgages whose 
interest rates were fixed for the first 2 or 3 years but then adjusted 
to often much higher interest rates and correspondingly higher mortgage 
payments. In addition, many borrowers took out loans with interest-only 
features that resulted in significant increases in mortgage payments 
later in the loan. The combination of reduced underwriting standards 
and a slowdown in house price appreciation led many borrowers to 
default on their mortgages. 

Alternative mortgage products such as interest-only or payment option 
loans, which allow borrowers to defer repayment of principal and 
possibly part of the interest for the first few years of the loan, grew 
in popularity and expanded greatly in recent years. From 2003 through 
2005, originations of these types of mortgage products grew threefold, 
from less than 10 percent of residential mortgage originations to about 
30 percent. For many years, lenders had primarily marketed these 
products to wealthy and financially sophisticated borrowers as 
financial management tools. However, lenders increasingly marketed 
alternative mortgage products as affordability products that enabled a 
wider spectrum of borrowers to purchase homes they might not have been 
able to afford using a conventional fixed-rate mortgage. Lenders also 
increased the variety of such products offered after interest rates 
rose and adjustable rate mortgages became less attractive to borrowers. 

In past work, we found that most of the disclosures for alternative 
mortgage products that we reviewed did not always fully or effectively 
explain the risks associated with these products and lacked information 
on some important loan features.[Footnote 62] Some evidence suggests 
more generally that existing mortgage disclosures were inadequate, a 
problem that is likely to grow with the increased complexity of 
products. A 2007 Federal Trade Commission report found that both prime 
and subprime borrowers failed to understand key loan terms when viewing 
current disclosures.[Footnote 63] In addition, some market observers 
have been critical of regulators' oversight of these products and 
whether products with such complex features were appropriate for some 
of the borrowers to which they were marketed. For example, some were 
critical of the Federal Reserve for not acting more quickly to use its 
authority under the 1994 Home Ownership and Equity Protection Act to 
prohibit unfair or deceptive acts or practices in the mortgage market. 
Although the Federal Reserve took steps in 2001 to ban some practices, 
such as engaging in a pattern or practice of refinancing certain high- 
cost loans when it is not in the borrower's interest, it did not act 
again until 2008, when it banned additional products and practices, 
such as certain loans with limited documentation. In a 2007 testimony, 
a Federal Reserve official noted that writing such rules is difficult, 
particularly since determinations of unfairness or deception depend 
heavily on the facts of an individual case.[Footnote 64] 

Efforts by regulators to respond to the increased risks associated with 
new mortgage products also have sometimes been slowed in part because 
of the need for five federal regulators to coordinate their response. 
In late 2005, regulators began crafting regulatory guidance to 
strengthen lending practices and improve disclosures for loans that 
start with relatively low payments but leave borrowers vulnerable to 
much higher ones later. The regulators completed their first set of 
such standards in September 2006, with respect to the disclosure of 
risks associated with nontraditional mortgage products, and a second 
set, applicable to subprime mortgage loans, in June 2007.[Footnote 65] 
Some industry observers and consumer advocacy groups have criticized 
the length of time it took for regulators to issue these changes, 
noting that the second set of guidance was released well after many 
subprime lenders had already gone out of business. 

As variations in the types of credit card products and terms have 
proliferated, consumers also have faced difficulty understanding the 
rates and terms of their credit card accounts. Credit card rate and fee 
disclosures have not always been effective at clearly conveying 
associated charges and fees, creating challenges to informed financial 
decision making. Although credit card issuers are required to provide 
cardholders with information aimed at facilitating informed use of 
credit, these disclosures have serious weaknesses that likely reduce 
consumers' ability to understand the costs of using credit cards. 
Because the pricing of credit cards is not generally subject to federal 
regulation, these disclosures are the primary federal consumer 
protection mechanism against inaccurate and unfair credit card 
practices. However, we reported in 2006 that the disclosures in 
materials provided by four of the largest credit card issuers were too 
complicated for many consumers to understand. Following our report, 
Federal Reserve staff began using consumer testing to involve them to a 
greater extent in the preparation of potentially new and revised 
disclosures, and in May 2007, issued proposed changes to credit card 
disclosure requirements. Nonetheless, the Federal Reserve recognizes 
the challenge of presenting the information that consumers may need to 
understand the costs of their cards in a clear way, given the 
increasingly complicated terms of credit card products.[Footnote 66] In 
December 2008, the Federal Reserve, OTS, and NCUA finalized rules to 
ban various unfair credit card practices, such as allocating payments 
in a way that unfairly maximizes interest charges. 

The expansion of new and more complex products also raises challenges 
for regulators in addressing financial literacy. We have also noted in 
past work that even a relatively clear and transparent system of 
disclosures may be of limited use to borrowers who lack sophistication 
about financial matters.[Footnote 67] In response to increasing 
evidence that many Americans are lacking in financial literacy, the 
federal government has taken steps to expand financial education 
efforts. However, attempts by the Financial Literacy and Education 
Commission to coordinate federal financial literacy efforts have 
sometimes proven difficult due, in part, to the need to reach consensus 
among its 20 participating federal agencies, which have different 
missions and perspectives. Moreover, the commission's staff and funding 
resources are relatively small, and it has no legal authority to 
require agencies to redirect their resources or take other actions. 
[Footnote 68] 

Increased Complexity and Other Factors Have Challenged Accounting 
Standard Setters and Regulators: 

As new and increasingly complex financial products have become more 
common, FASB and SEC have also faced challenges in trying to ensure 
that accounting and financial reporting requirements appropriately meet 
the needs of investors and other financial market participants. 
[Footnote 69] The development and widespread use of increasingly 
complex financial products has heightened the importance of having 
effective accounting and financial reporting requirements that provide 
interested parties with information that can help them identify and 
assess risk. As the pace of financial innovation increased in the last 
30 years, accounting and financial reporting requirements have also had 
to keep pace, with 72 percent of the current 163 standards having been 
issued since 1980--some of which were revisions and amendments to 
recently established standards, which evidences the challenge of 
establishing accounting and financial reporting requirements that 
respond to needs created by financial innovation. 

As a result of the growth in complex financial instruments and a desire 
to improve the usefulness of financial information about them, U.S. 
standard setters and regulators currently are dealing with accounting 
and auditing challenges associated with recently developed standards 
related to valuing financial instruments and special-purpose entities. 
Over the last year, owners and issuers of financial instruments have 
expressed concerns about implementing the new fair value accounting 
standard, which requires that financial assets and liabilities be 
recorded at fair or market value. SEC and FASB have recently issued 
clarifications of measuring fair value when there is not an active 
market for the financial instrument.[Footnote 70] In addition, market 
participants raised concerns about the availability of useful 
accounting and financial reporting information to assess the risks 
posed by special-purpose entities. Under current accounting rules, 
publicly traded companies that create qualifying special-purpose 
entities are allowed to move qualifying assets and liabilities 
associated with certain complex financial instruments off the issuing 
company's balance sheets, which results in virtually no accounting and 
financial reporting information being available about the entities' 
activities. Due to the accounting and financial reporting treatment for 
these special-purpose entities, as the subprime crisis worsened, banks 
initially refused to negotiate loans with homeowners because banks were 
concerned that the accounting and financial reporting requirements 
would have the banks put the assets and liabilities back onto their 
balance sheets. In response to questions regarding modification of 
loans in special-purpose entities, the SEC's Chief Accountant issued a 
letter that concluded his office would not object to loans being 
modified pursuant to specific screening criteria. In response to these 
concerns, FASB expedited its standards-setting process in order to 
reduce the amount of time before the issuance of a new accounting 
standard that would effectively eliminate qualified special-purpose 
entities.[Footnote 71] 

Standard setters and regulators also face new challenges in dealing 
with global convergence of accounting and auditing standards. The rapid 
integration of the world's capital markets has made establishing a 
single set of effective accounting and financial reporting standards 
increasingly relevant. FASB and SEC have acknowledged the need to 
address the convergence of U.S. and international accounting standards, 
and SEC has proposed having U.S. public companies use International 
Financial Reporting Standards by 2014. As the globalization of 
accounting standards moves forward, U.S. standard setters and 
regulators need to anticipate and manage the challenges posed by their 
development and implementation, such as how to apply certain standards 
in unique legal and regulatory environment frameworks in the United 
States as well as in certain unique industry niches. Ensuring that 
auditing standards applicable to U.S. public companies continue to 
provide the financial markets with the important and independent 
assurances associated with existing U.S. auditing standards will also 
prove challenging to the Public Company Accounting Oversight Board. 

Globalization Will Further Challenge the Existing U.S. Regulatory 
System: 

Just as global accounting and auditing standards are converging, 
financial markets around the world are becoming increasingly 
interlinked and global in nature, requiring U.S. regulators to work 
with each other and other countries to effectively adapt. To 
effectively oversee large financial services firms that have operations 
in many countries, regulators from various countries must coordinate 
regulation and supervision of financial services across national 
borders and must communicate regularly. Although financial regulators 
have effectively coordinated in a number of ways to accommodate some 
changes, the current fragmented regulatory structure has complicated 
some of these efforts. 

For example, the current U.S. regulatory system complicates the ability 
of financial regulators to convey a single U.S. position in 
international discussions, such as those related to the Basel Accords 
process for developing international capital standards. Each federal 
regulator involved in these efforts oversees a different set of 
institutions and represents an important regulatory perspective, which 
has made reaching consensus on some issues more difficult than others. 
Although U.S. regulators generally agree on the broad underlying 
principles at the core of Basel II, including increased risk 
sensitivity of capital requirements and capital neutrality, in a 2004 
report we noted that although regulators communicated and coordinated, 
they sometimes had difficulty agreeing on certain aspects of the 
process.[Footnote 72] As we reported, in November 2003, members of the 
House Financial Services Committee warned in a letter to the bank 
regulatory agencies that the discord surrounding Basel II had weakened 
the negotiating position of the United States and resulted in an 
agreement that was less than favorable to U.S. financial institutions. 
[Footnote 73] International officials have also indicated that the lack 
of a single point of contact on, for example, insurance issues has 
complicated regulatory decision making. However, regulatory officials 
told us that the final outcome of the Basel II negotiations was better 
than it would have been with a single U.S. representative because of 
the agencies' varying perspectives and expertise. In particular, one 
regulator noted that, in light of the magnitude of recent losses at 
banks and the failure of banks and rating agencies to predict such 
losses, the additional safeguards built into how U.S. regulators 
adopted Basel II are an example of how more than one regulatory 
perspective can improve policymaking. 

A Framework for Crafting and Assessing Alternatives for Reforming the 
U.S. Financial Regulatory System: 

The U.S. regulatory system is a fragmented and complex system of 
federal and state regulators--put into place over the past 150 years-- 
that has not kept pace with the major developments that have occurred 
in financial markets and products in recent decades. In 2008, the 
United States finds itself in the midst of one of the worst financial 
crises ever, with instability threatening global financial markets and 
the broader economy. While much of the attention of policymakers 
understandably has been focused on taking short-term steps to address 
the immediate nature of the crisis, attention has also turned to the 
need to consider significant reforms to the financial regulatory system 
to keep pace with existing and anticipated challenges in financial 
regulation. 

While the current U.S. system has many features that could be 
preserved, the significant limitations of the system, if not addressed, 
will likely fail to prevent future crises that could be as harmful as 
or worse than those that have occurred in the past. Making changes that 
better position regulators to oversee firms and products that pose 
risks to the financial system and consumers and to adapt to new 
products and participants as these arise would seem essential to 
ensuring that our financial services sector continues to serve our 
nation's needs as effectively as possible. 

We have conducted extensive work in recent decades reviewing the 
impacts of market developments and overseeing the effectiveness of 
financial regulators' activities. In particular, we have helped 
Congress address financial crises dating back to the savings and loan 
and LTCM crises, and more recently over the past few years have issued 
several reports citing the need to modernize the U.S. financial 
regulatory structure. In this report, consistent with our past work, we 
are not proposing the form and structure of what a new financial 
regulatory system should look like. Instead, we are providing a 
framework, consisting of the following nine elements, that Congress and 
others can use to evaluate or craft proposals for financial regulatory 
reform. By applying the elements of this framework to proposals, the 
relative strengths and weaknesses of each one should be better 
revealed. Similarly, the framework we present could be used to craft a 
proposal or to identify aspects to be added to existing proposals to 
make them more effective and appropriate for addressing the limitations 
of the current system. The nine elements could be addressed in a 
variety of ways, but each is critically important in establishing the 
most effective and efficient financial regulatory system possible. 

1. Clearly defined regulatory goals. A regulatory system should have 
goals that are clearly articulated and relevant, so that regulators can 
effectively conduct activities to implement their missions. 

A critical first step to modernizing the regulatory system and 
enhancing its ability to meet the challenges of a dynamic financial 
services industry is to clearly define regulatory goals and objectives. 
In the background of this report, we identify four broad goals of 
financial regulation that regulators have generally sought to achieve. 
These include ensuring adequate consumer protections, ensuring the 
integrity and fairness of markets, monitoring the safety and soundness 
of institutions, and acting to ensure the stability of the overall 
financial system. However, these goals are not always explicitly set in 
the federal statutes and regulations that govern these regulators. 
Having specific goals clearly articulated in legislation could serve to 
better focus regulators on achieving their missions with greater 
certainty and purpose, and provide continuity over time. 

Given some of the key changes in financial markets discussed earlier in 
this report--particularly the increased interconnectedness of 
institutions, the increased complexity of products, and the 
increasingly global nature of financial markets--Congress should 
consider the benefits that may result from re-examining the goals of 
financial regulation and making explicit a set of comprehensive and 
cohesive goals that reflect today's environment. For example, it may be 
beneficial to have a clearer focus on ensuring that products are not 
sold with unsuitable, unfair, deceptive, or abusive features; that 
systemic risks and the stability of the overall financial system are 
specifically addressed; or that U.S. firms are competitive in a global 
environment. This may be especially important given the history of 
financial regulation and the ad hoc approach through which the existing 
goals have been established, as discussed earlier. 

We found varying views about the goals of regulation and how they 
should be prioritized. For example, representatives of some regulatory 
agencies and industry groups emphasized the importance of creating a 
competitive financial system, whereas members of one consumer advocacy 
group noted that reforms should focus on improving regulatory 
effectiveness rather than addressing concerns about market 
competitiveness. In addition, as the Federal Reserve notes, financial 
regulatory goals often will prove interdependent and at other times may 
conflict. 

Revisiting the goals of financial regulation would also help ensure 
that all involved entities--legislators, regulators, institutions, and 
consumers--are able to work jointly to meet the intended goals of 
financial regulation. Such goals and objectives could help establish 
agency priorities and define responsibility and accountability for 
identifying risks, including those that cross markets and industries. 
Policymakers should also carefully define jurisdictional lines and 
weigh the advantages and disadvantages of having overlapping 
authorities. While ensuring that the primary goals of financial 
regulation--including system soundness, market integrity, and consumer 
protection--are better articulated for regulators, policymakers will 
also have to ensure that regulation is balanced with other national 
goals, including facilitating capital raising, innovation, and other 
benefits that foster long-term growth, stability, and welfare of the 
United States. 

Once these goals are agreed upon, policymakers will need to determine 
the extent to which goals need to be clarified and specified through 
rules and requirements, or whether to avoid such specificity and 
provide regulators with greater flexibility in interpreting such goals. 
Some reform proposals suggest "principles-based regulation" in which 
regulators apply broad-based regulatory principles on a case-by-case 
basis. Such an approach offers the potential advantage of allowing 
regulators to better adapt to changing market developments. Proponents 
also note that such an approach would prevent institutions in a more 
rules-based system from complying with the exact letter of the law 
while still engaging in unsound or otherwise undesirable financial 
activities. However, such an approach has potential limitations. 
Opponents note that regulators may face challenges to implement such a 
subjective set of principles. A lack of clear rules about activities 
could lead to litigation if financial institutions and consumers alike 
disagree with how regulators interpreted goals. Opponents of principles-
based regulation note that industry participants who support such an 
approach have also in many cases advocated for bright-line standards 
and increased clarity in regulation, which may be counter to a 
principles-based system. The most effective approach may involve both a 
set of broad underlying principles and some clear technical rules 
prohibiting specific activities that have been identified as 
problematic. 

Key issues to be addressed: 

* Clarify and update the goals of financial regulation and provide 
sufficient information on how potentially conflicting goals might be 
prioritized. 

* Determine the appropriate balance of broad principles and specific 
rules that will result in the most effective and flexible 
implementation of regulatory goals. 

2. Appropriately comprehensive. A regulatory system should ensure that 
financial institutions and activities are regulated in a way that 
ensures regulatory goals are fully met. As such, activities that pose 
risks to consumer protection, financial stability, or other goals 
should be comprehensively regulated, while recognizing that not all 
activities will require the same level of regulation. 

A financial regulatory system should effectively meet the goals of 
financial regulation, as articulated as part of this process, in a way 
that is appropriately comprehensive. In doing so, policymakers may want 
to consider how to ensure that both the breadth and depth of regulation 
are appropriate and adequate. That is, policymakers and regulators 
should consider how to make determinations about which activities and 
products, both new and existing, require some aspect of regulatory 
involvement to meet regulatory goals, and then make determinations 
about how extensive such regulation should be. As we have noted, gaps 
in the current level of federal oversight of mortgage lenders, credit 
rating agencies, and certain complex financial products such as CDOs 
and credit default swaps likely have contributed to the current crisis. 
Congress and regulators may also want to revisit the extent of 
regulation for entities such as banks that have traditionally fallen 
within full federal oversight but for which existing regulatory 
efforts, such as oversight related to risk management and lending 
standards, have been proven in some cases inadequate by recent events. 
However, overly restrictive regulation can stifle the financial 
sectors' ability to innovate and stimulate capital formation and 
economic growth. Regulators have struggled to balance these competing 
objectives, and the current crisis appears to reveal that the proper 
balance was not in place in the regulatory system to date. 

Key issues to be addressed: 

* Identify risk-based criteria, such as a product's or institution's 
potential to harm consumers or create systemic problems, for 
determining the appropriate level of oversight for financial activities 
and institutions. 

* Identify ways that regulation can provide protection but avoid 
hampering innovation, capital formation, and economic growth. 

3. Systemwide focus. A regulatory system should include a mechanism for 
identifying, monitoring, and managing risks to the financial system 
regardless of the source of the risk or the institutions in which it is 
created. 

A regulatory system should focus on risks to the financial system, not 
just institutions. As noted earlier, with multiple regulators primarily 
responsible for individual institutions or markets, none of the 
financial regulators is tasked with assessing the risks posed across 
the entire financial system by a few institutions or by the collective 
activities of the industry. As we noted earlier in the report, the 
collective activities of a number of entities--including mortgage 
brokers, real estate professionals, lenders, borrowers, securities 
underwriters, investors, rating agencies and others--likely all 
contributed to the recent market crisis, but no one regulator had the 
necessary scope of oversight to identify the risks to the broader 
financial system. Similarly, once firms began to fail and the full 
extent of the financial crisis began to become clear, no formal 
mechanism existed to monitor market trends and potentially stop or help 
mitigate the fallout from these events. 

Having a single entity responsible for assessing threats to the overall 
financial system could prevent some of the crises that we have seen in 
the past. For example, in its Blueprint for a Modernized Financial 
Regulatory Structure, Treasury proposed expanding the responsibilities 
of the Federal Reserve to create a "market stability regulator" that 
would have broad authority to gather and disclose appropriate 
information, collaborate with other regulators on rulemaking, and take 
corrective action as necessary in the interest of overall financial 
market stability. Such a regulator could assess the systemic risks that 
arise at financial institutions, within specific financial sectors, 
across the nation, and globally. However, policymakers should consider 
that a potential disadvantage of providing the agency with such broad 
responsibility for overseeing nonbank entities could be that it may 
imply an official government support or endorsement, such as a 
government guarantee, of such activities, and thus encourage greater 
risk taking by these financial institutions and investors. 

Regardless of whether a new regulator is created, all regulators under 
a new system should consider how their activities could better identify 
and address systemic risks posed by their institutions. As the Federal 
Reserve Chairman has noted, regulation and supervision of financial 
institutions is a critical tool for limiting systemic risk. This will 
require broadening the focus from individual safety and soundness of 
institutions to a systemwide oversight approach that includes potential 
systemic risks and weaknesses. 

A systemwide focus should also increase attention on how the incentives 
and constraints created by regulations affects risk taking throughout 
the business cycle, and what actions regulators can take to anticipate 
and mitigate such risks. However, as the Federal Reserve Chairman has 
noted, the more comprehensive the approach, the more technically 
demanding and costly it would be for regulators and affected 
institutions. 

Key issues to be addressed: 

* Identify approaches to broaden the focus of individual regulators or 
establish new regulatory mechanisms for identifying and acting on 
systemic risks. 

* Determine what additional authorities a regulator or regulators 
should have to monitor and act to reduce systemic risks. 

4. Flexible and adaptable. A regulatory system should be adaptable and 
forward-looking such that regulators can readily adapt to market 
innovations and changes and include a mechanism for evaluating 
potential new risks to the system. 

A regulatory system should be designed such that regulators can readily 
adapt to market innovations and changes and include a formal mechanism 
for evaluating the full potential range of risks of new products and 
services to the system, market participants, and customers. An 
effective system could include a mechanism for monitoring market 
developments--such as broad market changes that introduce systemic 
risk, or new products and services that may pose more confined risks to 
particular market segments--to determine the degree, if any, to which 
regulatory intervention might be required. The rise of a very large 
market for credit derivatives, while providing benefits to users, also 
created exposures that warranted actions by regulators to rescue large 
individual participants in this market. While efforts are under way to 
create risk-reducing clearing mechanisms for this market, a more 
adaptable and responsive regulatory system might have recognized this 
need earlier and addressed it sooner. Some industry representatives 
have suggested that principles-based regulation, as discussed above, 
would provide such a mechanism. Designing a system to be flexible and 
proactive also involves determining whether Congress, regulators, or 
both should make such determinations, and how such an approach should 
be clarified in laws or regulations. 

Important questions also exist about the extent to which financial 
regulators should actively monitor and, where necessary, approve new 
financial products and services as they are developed to ensure the 
least harm from inappropriate products. Some individuals commenting on 
this framework, including industry representatives, noted that limiting 
government intervention in new financial activities until it has become 
clear that a particular activity or market poses a significant risk and 
therefore warrants intervention may be more appropriate. As with other 
key policy questions, this may be answered with a combination of both 
approaches, recognizing that a product approval approach may be 
appropriate for some innovations with greater potential risk, while 
other activities may warrant a more reactive approach. 

Key issues to be addressed: 

* Determine how to effectively monitor market developments to identify 
potential risks; the degree, if any, to which regulatory intervention 
might be required; and who should hold such a responsibility. 

* Consider how to strike the right balance between overseeing new 
products as they come onto the market to take action as needed to 
protect consumers and investors, without unnecessarily hindering 
innovation. 

5. Efficient and effective. A regulatory system should provide 
efficient oversight of financial services by eliminating overlapping 
federal regulatory missions, where appropriate, and minimizing 
regulatory burden while effectively achieving the goals of regulation. 

A regulatory system should provide for the efficient and effective 
oversight of financial services. Accomplishing this in a regulatory 
system involves many considerations. First, an efficient regulatory 
system is designed to accomplish its regulatory goals using the least 
amount of public resources. In this sense, policymakers must consider 
the number, organization, and responsibilities of each agency, and 
eliminate undesirable overlap in agency activities and 
responsibilities. Determining what is undesirable overlap is a 
difficult decision in itself. Under the current U.S. system, financial 
institutions often have several options for how to operate their 
business and who will be their regulator. For example, a new or 
existing depository institution can choose among several charter 
options. Having multiple regulators performing similar functions does 
allow for these agencies to potentially develop alternative or 
innovative approaches to regulation separately, with the approach 
working best becoming known over time. Such proven approaches can then 
be adopted by the other agencies. On the other hand, this could lead to 
regulatory arbitrage, in which institutions take advantage of 
variations in how agencies implement regulatory responsibilities in 
order to be subject to less scrutiny. Both situations have occurred 
under our current structure. 

With that said, recent events clearly have shown that the fragmented 
U.S. regulatory structure contributed to failures by the existing 
regulators to adequately protect consumers and ensure financial 
stability. As we noted earlier, efforts by regulators to respond to the 
increased risks associated with new mortgage products were sometimes 
slowed in part because of the need for five federal regulators to 
coordinate their response. The Chairman of the Federal Reserve has 
similarly noted that the different regulatory and supervisory regimes 
for lending institutions and mortgage brokers made monitoring such 
institutions difficult for both regulators and investors. Similarly, we 
noted earlier in the report that the current fragmented U.S. regulatory 
structure has complicated some efforts to coordinate internationally 
with other regulators. 

One first step to addressing such problems is to seriously consider the 
need to consolidate depository institution oversight among fewer 
agencies. Since 1996, we have been recommending that the number of 
federal agencies with primary responsibilities for bank oversight be 
reduced. Such a move would result in a system that was more efficient 
and improve consistency in regulation, another important characteristic 
of an effective regulatory system. In addition, Congress could consider 
the advantages and disadvantages of providing a federal charter option 
for insurance and creating a federal insurance regulatory entity. We 
have not studied the issue of an optional federal charter for insurers, 
but have through the years noted difficulties with efforts to harmonize 
insurance regulation across states through the NAIC-based structure. 
The establishment of a federal insurance charter and regulator could 
help alleviate some of these challenges, but such an approach could 
also have unintended consequences for state regulatory bodies and for 
insurance firms as well. 

Also, given the challenges associated with increasingly complex 
investment and retail products as discussed earlier, policymakers will 
need to consider how best to align agency responsibilities to better 
ensure that consumers and investors are provided with clear, concise, 
and effective disclosures for all products. 

Organizing agencies around regulatory goals as opposed to the existing 
sector-based regulation may be one way to improve the effectiveness of 
the system, especially given some of the market developments discussed 
earlier. Whatever the approach, policymakers should seek to minimize 
conflict in regulatory goals across regulators, or provide for 
efficient mechanisms to coordinate in cases where goals inevitably 
overlap. For example, in some cases, the safety and soundness of an 
individual institution may have implications for systemic risk, or 
addressing an unfair or deceptive act or practice at a financial 
institution may have implications on the institution's safety and 
soundness by increasing reputational risk. If a regulatory system 
assigns these goals to different regulators, it will be important to 
establish mechanisms for them to coordinate. 

Proposals to consolidate regulatory agencies for the purpose of 
promoting efficiency should also take into account any potential trade- 
offs related to effectiveness. For example, to the extent that 
policymakers see value in the ability of financial institutions to 
choose their regulator, consolidating certain agencies may reduce such 
benefits. Similarly, some individuals have commented that the current 
system of multiple regulators has led to the development of expertise 
among agency staff in particular areas of financial market activities 
that might be threatened if the system were to be consolidated. 
Finally, policymakers may want to ensure that any transition from the 
current financial system to a new structure should minimize as best as 
possible any disruption to the operation of financial markets or risks 
to the government, especially given the current challenges faced in 
today's markets and broader economy. 

A financial system should also be efficient by minimizing the burden on 
regulated entities to the extent possible while still achieving 
regulatory goals. Under our current system, many financial 
institutions, and especially large institutions that offer services 
that cross sectors, are subject to supervision by multiple regulators. 
While steps toward consolidated supervision and designating primary 
supervisors have helped alleviate some of the burden, industry 
representatives note that many institutions face significant costs as a 
result of the existing financial regulatory system that could be 
lessened. Such costs, imposed in an effort to meet certain regulatory 
goals such as safety and soundness and consumer protection, can run 
counter to other goals of a financial system by stifling innovation and 
competitiveness. In addressing this concern, it is also important to 
consider the potential benefits that might result in some cases from 
having multiple regulators overseeing an institution. For example, 
representatives of state banking and other institution regulators, and 
consumer advocacy organizations, note that concurrent jurisdiction-- 
between two federal regulators or a federal and state regulator--can 
provide needed checks and balances against individual financial 
regulators who have not always reacted appropriately and in a timely 
way to address problems at institutions. They also note that states may 
move more quickly and more flexibly to respond to activities causing 
harm to consumers. Some types of concurrent jurisdiction, such as 
enforcement authority, may be less burdensome to institutions than 
others, such as ongoing supervision and examination. 

Key issues to be addressed: 

* Consider the appropriate role of the states in a financial regulatory 
system and how federal and state roles can be better harmonized. 

* Determine and evaluate the advantages and disadvantages of having 
multiple regulators, including nongovernmental entities such as SROs, 
share responsibilities for regulatory oversight. 

* Identify ways that the U.S. regulatory system can be made more 
efficient, either through consolidating agencies with similar roles or 
through minimizing unnecessary regulatory burden. 

* Consider carefully how any changes to the financial regulatory system 
may negatively impact financial market operations and the broader 
economy, and take steps to minimize such consequences. 

6. Consistent consumer and investor protection. A regulatory system 
should include consumer and investor protection as part of the 
regulatory mission to ensure that market participants receive 
consistent, useful information, as well as legal protections for 
similar financial products and services, including disclosures, sales 
practice standards, and suitability requirements. 

A regulatory system should be designed to provide high-quality, 
effective, and consistent protection for consumers and investors in 
similar situations. In doing so, it is important to recognize important 
distinctions between retail consumers and more sophisticated consumers 
such as institutional investors, where appropriate considering the 
context of the situation. Different disclosures and regulatory 
protections may be necessary for these different groups. Consumer 
protection should be viewed from the perspective of the consumer rather 
than through the various and sometimes divergent perspectives of the 
multitude of federal regulators that currently have responsibilities in 
this area. 

As discussed earlier, many consumers that received loans in the last 
few years did not understand the risks associated with taking out their 
loans, especially in the event that housing prices would not continue 
to increase at the rate they had in recent years. In addition, 
increasing evidence exists that many Americans are lacking in financial 
literacy, and the expansion of new and more complex products will 
continue to create challenges in this area. Furthermore, as noted 
above, regulators with existing authority to better protect consumers 
did not always exercise that authority effectively. In considering a 
new regulatory system, policymakers should consider the significant 
lapses in our regulatory system's focus on consumer protection and 
ensure that such a focus is prioritized in any reform efforts. For 
example, policymakers should identify ways to improve upon the 
existing, largely fragmented, system of regulators that must coordinate 
to act in these areas. As noted above, this should include serious 
consideration of whether to consolidate regulatory responsibilities to 
streamline and improve the effectiveness of consumer protection 
efforts. Another way that some market observers have argued that 
consumer protections could be enhanced and harmonized across products 
is to extend suitability requirements--which require securities brokers 
making recommendations to customers to have reasonable grounds for 
believing that the recommendation is suitable for the customer--to 
mortgage and other products. Additional consideration could also be 
given to determining whether certain products are simply too complex to 
be well understood and make judgments about limiting or curtailing 
their use. 

Key issues to be addressed: 

* Consider how prominent the regulatory goal of consumer protection 
should be in the U.S. financial regulatory system. 

* Determine what amount, if any, of consolidation of responsibility may 
be necessary to enhance and harmonize consumer protections, including 
suitability requirements and disclosures across the financial services 
industry. 

* Consider what distinctions are necessary between retail and wholesale 
products, and how such distinctions should affect how products are 
regulated. 

* Identify opportunities to protect and empower consumers through 
improving their financial literacy. 

7. Regulators provided with independence, prominence, authority, and 
accountability. A regulatory system should ensure that regulators have 
independence from inappropriate influence; have sufficient resources, 
clout, and authority to carry out and enforce statutory missions; and 
are clearly accountable for meeting regulatory goals. 

A regulatory system should ensure that any entity responsible for 
financial regulation is independent from inappropriate influence; has 
adequate prominence, authority, and resources to carry out and enforce 
its statutory mission; and is clearly accountable for meeting 
regulatory goals. With respect to independence, policymakers may want 
to consider advantages and disadvantages of different approaches to 
funding agencies, especially to the extent that agencies might face 
difficulty remaining independent if they are funded by the institutions 
they regulate. Under the current structure, for example, the Federal 
Reserve primarily is funded by income earned from U.S. government 
securities that it has acquired through open market operations and does 
not assess charges to the institutions it oversees. In contrast, OCC 
and OTS are funded primarily by assessments on the firms they 
supervise. Decision makers should consider whether some of these 
various funding mechanisms are more likely to ensure that a regulator 
will take action against its regulated institutions without regard to 
the potential impact on its own funding. 

With respect to prominence, each regulator must receive appropriate 
attention and support from top government officials. Inadequate 
prominence in government may make it difficult for a regulator to raise 
safety and soundness or other concerns to Congress and the 
administration in a timely manner. Mere knowledge of a deteriorating 
situation would be insufficient if a regulator were unable to persuade 
Congress and the administration to take timely corrective action. This 
problem would be exacerbated if a regulated institution had more 
political clout and prominence than its regulator because the 
institution could potentially block action from being taken. 

In considering authority, agencies must have the necessary enforcement 
and other tools to effectively implement their missions to achieve 
regulatory goals. For example, as noted earlier, in a 2007 report we 
expressed concerns over the appropriateness of having OTS oversee 
diverse global financial firms given the size of the agency relative to 
the institutions for which it was responsible.[Footnote 74] It is 
important for a regulatory system to ensure that agencies are provided 
with adequate resources and expertise to conduct their work 
effectively. A regulatory system should also include adequate checks 
and balances to ensure the appropriate use of agency authorities. With 
respect to accountability, policymakers may also want to consider 
different governance structures at agencies--the current system 
includes a combination of agency heads and independent boards or 
commissions--and how to ensure that agencies are recognized for 
successes and held accountable for failures to act in accordance with 
regulatory goals. 

Key issues to be addressed: 

* Determine how to structure and fund agencies to ensure each has 
adequate independence, prominence, tools, authority and accountability. 

* Consider how to provide an appropriate level of authority to an 
agency while ensuring that it appropriately implements its mission 
without abusing its authority. 

* Ensure that the regulatory system includes effective mechanisms for 
holding regulators accountable. 

8. Consistent financial oversight. A regulatory system should ensure 
that similar institutions, products, risks, and services are subject to 
consistent regulation, oversight, and transparency, which should help 
minimize negative competitive outcomes while harmonizing oversight, 
both within the United States and internationally. 

A regulatory system should ensure that similar institutions, products, 
and services posing similar risks are subject to consistent regulation, 
oversight, and transparency. Identifying which institutions and which 
of their products and services pose similar risks is not easy and 
involves a number of important considerations. Two institutions that 
look very similar may in fact pose very different risks to the 
financial system, and therefore may call for significantly different 
regulatory treatment. However, activities that are done by different 
types of financial institutions that pose similar risks to their 
institutions or the financial system should be regulated similarly to 
prevent competitive disadvantages between institutions. 

Streamlining the regulation of similar products across sectors could 
also help prepare the United States for challenges that may result from 
increased globalization and potential harmonization in regulatory 
standards. Such efforts are under way in other jurisdictions. For 
example, at a November 2008 summit in the United States, the Group of 
20 countries pledged to strengthen their regulatory regimes and ensure 
that all financial markets, products, and participants are consistently 
regulated or subject to oversight, as appropriate to their 
circumstances. Similarly, a working group in the European Union is 
slated by the spring of 2009 to propose ways to strengthen European 
supervisory arrangements, including addressing how their supervisors 
should cooperate with other major jurisdictions to help safeguard 
financial stability globally. Promoting consistency in regulation of 
similar products should be done in a way that does not sacrifice the 
quality of regulatory oversight. 

As we noted in a 2004 report, different regulatory treatment of bank 
and financial holding companies, consolidated supervised entities, and 
other holding companies may not provide a basis for consistent 
oversight of their consolidated risk management strategies, guarantee 
competitive neutrality, or contribute to better oversight of systemic 
risk. Recent events further underscore the limitations brought about 
when there is a lack of consistency in oversight of large financial 
institutions. As such, Congress and regulators will need to seriously 
consider how best to consolidate responsibilities for oversight of 
large financial conglomerates as part of any reform effort. 

Key issues to be addressed: 

* Identify institutions and products and services that pose similar 
risks. 

* Determine the level of consolidation necessary to streamline 
financial regulation activities across the financial services industry. 

* Consider the extent to which activities need to be coordinated 
internationally. 

9. Minimal taxpayer exposure. A regulatory system should have adequate 
safeguards that allow financial institution failures to occur while 
limiting taxpayers' exposure to financial risk. 

A regulatory system should have adequate safeguards that allow 
financial institution failures to occur while limiting taxpayers' 
exposure to financial risk. Policymakers should consider identifying 
the best safeguards and assignment of responsibilities for responding 
to situations where taxpayers face significant exposures, and should 
consider providing clear guidelines when regulatory intervention is 
appropriate. While an ideal system would allow firms to fail without 
negatively affecting other firms--and therefore avoid any moral hazard 
that may result--policymakers and regulators must consider the 
realities of today's financial system. In some cases, the immediate use 
of public funds to prevent the failure of a critically important 
financial institution may be a worthwhile use of such funds if it 
ultimately serves to prevent a systemic crisis that would result in 
much greater use of public funds in the long run. However, an effective 
regulatory system that incorporates the characteristics noted above, 
especially by ensuring a systemwide focus, should be better equipped to 
identify and mitigate problems before it become necessary to make 
decisions about whether to let a financial institution fail. 

An effective financial regulatory system should also strive to minimize 
systemic risks resulting from interrelationships between firms and 
limitations in market infrastructures that prevent the orderly 
unwinding of firms that fail. Another important consideration in 
minimizing taxpayer exposure is to ensure that financial institutions 
provided with a government guarantee that could result in taxpayer 
exposure are also subject to an appropriate level of regulatory 
oversight to fulfill the responsibilities discussed above. 

Key issues to be addressed: 

* Identify safeguards that are most appropriate to prevent systemic 
crises while minimizing moral hazard. 

* Consider how a financial system can most effectively minimize 
taxpayer exposure to losses related to financial instability. 

Finally, although significant changes may be required to modernize the 
U.S. financial regulatory system, policymakers should consider 
carefully how best to implement the changes in such a way that the 
transition to a new structure does not hamper the functioning of the 
financial markets, individual financial institutions' ability to 
conduct their activities, and consumers' ability to access needed 
services. For example, if the changes require regulators or 
institutions to make systems changes, file registrations, or other 
activities that could require extensive time to complete, the changes 
could be implemented in phases with specific target dates around which 
the affected entities could formulate plans. 

In addition, our past work has identified certain critical factors that 
should be addressed to ensure that any large-scale transitions among 
government agencies are implemented successfully.[Footnote 75] Although 
all of these factors are likely important for a successful 
transformation for the financial regulatory system, Congress and 
existing agencies should pay particular attention to ensuring there are 
effective communication strategies so that all affected parties, 
including investors and consumers, clearly understand any changes being 
implemented. In addition, attention should be paid to developing a 
sound human capital strategy to ensure that any new or consolidated 
agencies are able to retain and attract additional quality staff during 
the transition period. Finally, policymakers should consider how best 
to retain and utilize the existing skills and knowledge base within 
agencies subject to changes as part of a transition. 

Comments from Agencies and Other Organizations, and Our Evaluation: 

We provided the opportunity to review and comment on a draft of this 
report to representatives of 29 agencies and other organizations, 
including federal and state financial regulatory agencies, consumer 
advocacy groups, and financial service industry trade associations. A 
complete list of organizations that reviewed the draft is included in 
appendix II. All reviewers provided valuable input that was used in 
finalizing this report. In general, reviewers commented that the report 
represented a high-quality and thorough review of issues related to 
regulatory reform. We made changes throughout the report to increase 
its precision and clarity and to provide additional detail. For 
example, the Federal Reserve provided comments indicating that our 
report should emphasize that the traditional goals of regulation that 
we described in the background section are incomplete unless their 
ultimate purpose is considered, which is to promote the long-term 
growth, stability, and welfare of the United States. As a result, we 
expanded the discussion of our framework element concerning the need to 
have clearly defined regulatory goals to emphasize that policymakers 
will need to ensure that such regulation is balanced with other 
national goals, including facilitating capital raising and fostering 
innovation. 

In addition, we received formal written responses from the American 
Bankers Association, the American Council of Life Insurers, the 
Conference of State Bank Supervisors, Consumers Union, the Credit Union 
National Association, the Federal Deposit Insurance Corporation, the 
Mortgage Bankers Association, and the National Association of Federal 
Credit Unions, and a joint letter from the Center for Responsible 
Lending, the National Consumer Law Center, and U.S. PIRG; all formal 
written responses are included as appendixes to this report. 

Among the letters we received, various commenters raised additional 
issues regarding consumer protection and risky products. For example, 
in a joint letter, the Center for Responsible Lending, the National 
Consumer Law Center, and the U.S. PIRG noted that the best way to avoid 
systemic risk is to address problems that exist at the level of 
individual consumer transactions, before they pose a threat to the 
system as a whole. They also noted that although most of the subprime 
lending was done by nonbank lenders, overly aggressive practices for 
other loan types and among other lenders also contributed to the 
current crisis. In addition, they noted that to effectively protect 
consumers, the regulatory system must prohibit unsustainable lending 
and that disclosures and financial literacy are not enough. The letter 
from FDIC agreed that effective reform of the U.S. financial regulatory 
system would help avoid a recurrence of the economic and financial 
problems we are now experiencing. It also noted that irresponsible 
lending practices were not consistent with sound banking practices. 
FDIC's letter also notes that the regulatory structure collectively 
permitted excessive levels of leverage in the nonbank financial system 
and that statutory mandates that address consumer protection and 
aggressive lending practices and leverage among firms would be equally 
important for improving regulation as would changing regulatory 
structure. In a letter from Consumers Union, that group urged that 
consumer protection be given equal priority as safety and soundness and 
that regulators act more promptly to address emerging risks rather than 
waiting until a problem has become national in scope. The letter 
indicates that Consumers Union supports an independent federal consumer 
protection agency for financial services and the ability of states to 
also develop and enforce consumer protections. We made changes in 
response to many of these comments. For example, we enhanced our 
discussion of weaknesses in regulators' efforts to oversee the sale of 
mortgage products that posed risks to consumers and the stability of 
the financial system, and we made changes to the framework to emphasize 
the importance of consumer protection. 

Several of the letters addressed issues regarding potential 
consolidation of regulatory agencies and the role of federal and state 
regulation. The letter from the American Bankers Association said that 
the current system of bank regulation and oversight has many advantages 
and that any reform efforts should build on those advantages. The 
letter also noted that there are benefits to having multiple federal 
regulators, as well as a dual banking system. The letter from the 
Conference of State Bank Supervisors agreed with our report that the 
U.S. regulatory system is complex and clearly has gaps, but cautioned 
that consolidating regulation and making decisions that could 
indirectly result in greater industry consolidation could exacerbate 
problems. The letter also indicates concern that our report does not 
fully acknowledge the importance of creating an environment that 
promotes a diverse industry to serve the nation's diverse communities 
and prevents concentration of economic power in a handful of 
institutions. Our report does discuss the benefits of state regulation 
of financial institutions, but we did not address the various types of 
state institutions because we focused mainly on the federal role over 
our markets. In the past, our work has acknowledged the dual banking 
system has benefits and that concentration in markets can have 
disadvantages. The Conference of State Bank Supervisors letter also 
notes that state efforts to respond to consumer abuses were stymied by 
federal preemption and that a regulatory structure should preserve 
checks and balances, avoid concentrations of power, and be more locally 
responsive. In response to this letter, we also added information about 
the enactment of the Secure and Fair Enforcement for Mortgage Licensing 
Act, as part of the Housing and Economic Recovery Act, which requires 
enhanced licensing and registration of mortgage brokers. 

The letter from the National Association of Federal Credit Unions urged 
that an independent regulator for credit unions be retained because of 
the distinctive characteristics of federal credit unions. A letter from 
the Credit Union National Association also strongly opposes combining 
the credit union regulator or its insurance function with another 
agency. The letter from the Mortgage Bankers Association urges that a 
federal standard for mortgage lending be developed to provide greater 
uniformity than the currently diffuse set of state laws. They also 
supported consideration of federal regulation of independent mortgage 
bankers and mortgage brokers as a way of improving uniformity and 
effectiveness of the regulation of these entities. A letter from the 
American Council of Life Insurers noted that the lack of a federal 
insurance regulatory office provides for uneven consumer protections 
and policy availability nationwide and hampers the country's ability to 
negotiate internationally on insurance industry issues, and urged that 
we include a discussion of the need to consider a greater federal role 
in the regulation of insurance. As a result, in the section where we 
discuss the need for efficient and effective regulation we noted that 
harmonizing insurance regulation across states has been difficult, and 
that Congress could consider the advantages and disadvantages of 
providing a federal charter option for insurance and creating a federal 
insurance regulatory entity. 

We are sending copies of this report to interested congressional 
committees and members. In addition, we are sending copies to the 
federal financial regulatory agencies and associations representing 
state financial regulators, financial industry participants, and 
consumers, as well as to the President and Vice President, the 
President-Elect and Vice President-Elect, and other interested parties. 
The report also is available at no charge on GAO's Web site at 
[hyperlink, http://www.gao.gov]. 

If you or your staffs have any questions about this report, please 
contact Orice M. Williams at (202) 512-8678 or williamso@gao.gov, or 
Richard J. Hillman at (202) 512-8678 or hillmanr@gao.gov. Contact 
points for our Offices of Congressional Relations and Public Affairs 
may be found on the last page of this report. GAO staff who made major 
contributions to this report are listed in appendix XII. 

Signed by: 

Gene L. Dodaro: 
Acting Comptroller General of the United States: 

List of Congressional Addressees: 

The Honorable Christopher J. Dodd: 
Chairman: 
The Honorable Richard C. Shelby: 
Ranking Member: 
Committee on Banking, Housing, and Urban Affairs: 
United States Senate: 

The Honorable Joseph I. Lieberman: 
Chairman: 
The Honorable Susan M. Collins: 
Ranking Member: 
Committee on Homeland Security and Governmental Affairs: 
United States Senate: 

The Honorable Barney Frank: 
Chairman: 
The Honorable Spencer Bachus: 
Ranking Member Committee on Financial Services: 
House of Representatives: 

The Honorable Edolphus Towns: 
Chairman: 
The Honorable Darrell E. Issa: 
Ranking Member: 
Committee on Oversight and Government Reform: 
House of Representatives: 

The Honorable Richard J. Durbin: 
The Honorable Tim Johnson: 
The Honorable Jack Reed: 
United States Senate: 

The Honorable Judy Biggert: 
The Honorable Paul E. Kanjorski: 
The Honorable Carolyn B. Maloney: 
The Honorable José E. Serrano: 
House of Representatives: 

[End of section] 

Appendix I: Scope and Methodology: 

Our report objectives were to (1) describe the origins of the current 
financial regulatory system, (2) describe various market developments 
and changes that have raised challenges for the current system, and (3) 
present an evaluation framework that can be used by Congress and others 
to craft or evaluate potential regulatory reform efforts going forward. 

To address all of these objectives, we synthesized existing GAO work on 
challenges to the U.S. financial regulatory structure and on criteria 
for developing and strengthening effective regulatory structures. These 
reports are referenced in footnotes in this report and noted in the 
Related GAO Products appendix. In particular, we relied extensively on 
our recent body of work examining the financial regulatory structure, 
culminating in reports issued in 2004 and 2007.[Footnote 76] We also 
reviewed existing studies, government documents, and other research for 
illustrations of how current and past financial market events have 
revealed limitations in our existing regulatory system and suggestions 
for regulatory reform. 

In addition, to gather input on challenges with the existing system and 
important considerations in evaluating reforms, we interviewed several 
key individuals with broad and substantial knowledge about the U.S. 
financial regulatory system--including a former Chairman of the Board 
of Governors of the Federal Reserve System (Federal Reserve), a former 
high-level executive at a major investment bank that had also served in 
various regulatory agencies, and an international financial 
organization official that also served in various regulatory agencies. 
We selected these individuals from a group of notable officials, 
academics, legal scholars, and others we identified as part of this and 
other GAO work, including a 2007 expert panel on financial regulatory 
structure. We selected individuals to interview in an effort to gather 
government, industry, and academic perspectives, including on 
international issues. In some cases, due largely to the market turmoil 
at the time of our study, we were unable to or chose not to reach out 
to certain individuals, but took steps to ensure that we selected other 
individuals that would meet our criteria. 

To develop the evaluation framework, we also convened a series of three 
forums in which we gathered comments on a preliminary draft of our 
framework from a wide range of representatives of federal and state 
financial regulatory agencies, financial industry associations and 
institutions, and consumer advocacy organizations. In particular, at a 
forum held on August 19, 2008, we gathered comments from 
representatives of financial industry associations and institutions, 
including the American Bankers Association, the American Council of 
Life Insurers, The Clearing House, Columbia Bank, the Independent 
Community Bankers of America, The Financial Services Roundtable, Fulton 
Financial Corporation, the Futures Industry Association, the Managed 
Funds Association, the Mortgage Bankers Association, the National 
Association of Federal Credit Unions, the Securities Industry and 
Financial Markets Association, and the U.S. Chamber of Commerce. We 
worked closely with representatives at the American Bankers 
Association--which hosted the forum at its Washington, D.C., 
headquarters--to identify a comprehensive and representative group of 
industry associations and institutions. 

At a forum held on August 27, 2008, we gathered comments from 
representatives of consumer advocacy organizations, including the 
Center for Responsible Lending, the Consumer Federation of America, the 
Consumers Union, the National Consumer Law Center, and the U.S. PIRG. 
We invited a comprehensive list of consumer advocacy organization 
representatives--compiled based on extensive dealings with these groups 
from current and past work--to participate in this forum and hosted it 
at GAO headquarters in Washington, D.C. 

At a forum held on August 28, 2008, we gathered comments from 
representatives of federal and state banking, securities, futures, 
insurance and housing regulatory oversight agencies, including the 
Commodity Futures Trading Commission, the Conference of State Bank 
Supervisors, the Department of the Treasury, the Federal Deposit 
Insurance Corporation, the Federal Housing Finance Agency, the Federal 
Reserve, the Financial Industry Regulatory Authority, the National 
Association of Insurance Commissioners, the National Credit Union 
Administration, the North American Securities Administrators 
Administration, the Office of the Comptroller of the Currency, the 
Office of Thrift Supervision, the Public Company Accounting Oversight 
Board, and the Securities and Exchange Commission. We worked closely 
with officials at the Federal Reserve--which hosted the forum at its 
Washington, D.C., headquarters--to identify a comprehensive and 
representative group of federal and state financial regulatory 
agencies. 

We conducted this work from April 2008 to December 2008 in accordance 
with generally accepted government auditing standards. Those standards 
require that we plan and perform the audit to obtain sufficient, 
appropriate evidence to provide a reasonable basis for our findings and 
conclusions based on our audit objectives. We believe that the evidence 
obtained provides a reasonable basis for our findings and conclusions 
based on our audit objectives. 

[End of section] 

Appendix II: Agencies and Other Organizations That Reviewed the Draft 
Report: 

American Bankers Association: 

American Council of Life Insurers: 

Center for Responsible Lending: 

Commodity Futures Trading Commission: 

Conference of State Bank Supervisors: 

Consumer Federation of America: 

Consumers Union: 

Credit Union National Association: 

Department of the Treasury: 

Federal Deposit Insurance Corporation: 

Federal Housing Finance Agency: 

Federal Reserve: 

Financial Industry Regulatory Authority: 

Financial Services Roundtable: 

Futures Industry Association: 

Independent Community Bankers of America: 

International Swaps and Derivates Association: 

Mortgage Bankers Association: 

National Association of Federal Credit Unions: 

National Association of Insurance Commissioners: 

National Consumer Law Center: 

National Credit Union Administration: 

National Futures Association: 

Office of the Comptroller of the Currency: 

Office of Thrift Supervision: 

Public Company Accounting Oversight Board: 

Securities and Exchange Commission: 

Securities Industry and Financial Markets Association: 

U.S. PIRG: 

[End of section] 

Appendix III: Comments from the American Bankers Association: 

American Bankers Association: 
1120 Connecticut Avenue, NW: 
Washington, DC 20036
1-800-Bankers: 
[hyperlink, http://www.aba.com] 

"World-Class Solutions, Leadership and Advocacy Since 1875" 

Denyette DePierro: 
Senior Counsel: 
Office of Regulatory Policy: 
Phone: 202-663-5333: 
Fax: 202-828-5047: 
ddepierr@aba.com: 

December 19, 2008: 
Ms. Orice M. Williams
Director
Financial Markets and Community Investment U.S. Government 
Accountability Office 441 G Street, N.W.
Washington, D.C. 20548
Dear Ms. Williams: 

The American Bankers Association[Footnote 77] (ABA) appreciates the 
opportunity to provide comments in connection with the Government 
Accountability Office's (GAO) draft report entitled, A Framework, or 
Crafting and Assessing Proposals to Modernize the Outdated U.S. 
Financial Regulatory System, which we understand is to be published in 
January, 2009. The purpose of the report is to identify existing 
problems with the financial regulatory system and craft a framework to 
assist in the evaluation of reform proposals. 

We believe that any review of the current regulatory system should 
begin with the recognition that banks have been and continue to be the 
primary institutions for saving, lending, and financing economic growth 
in our nation's communities. Banks arc also the leading players in the 
payments system and the only institutions that can he found 
participating in every stage of the payments system. Held to high 
standards of financial strength and integrity of operations, banks are 
well-poised to be engines of economic recovery and continued economic 
growth and development thereafter. 

Our customers include people and families from all walks of life and 
involve businesses of all sizes. The innovation and the diversity of 
the banking industry enable us to meet changing customer needs and 
interests. Through these efforts in recent decades more people have 
gained access to a wider array of banking products-and at lower costs 
than ever before, and better than anywhere else in the world. 

We support a regulatory program that fosters a climate in which we can 
build on these accomplishments and continue our progress in providing 
more and better services to more people and businesses at lower costs. 
With that in mind, we offer the following observations about ways in 
which changes to the current system could achieve these objectives. 

The central objective of regulatory reform efforts should be to enhance 
banks' ability to meet the needs of their customers. This objective has 
several facets. First, regulation needs to foster safe and sound 
operations. Second, it most provide appropriate consumer protections. 
Third, it needs to promote competition. And fourth, it must foster 
innovation and facilitate banks' ability to meet changing customer 
needs. These facets, while distinct, are wholly compatible. A financial 
institution will best be able to achieve its business objectives by 
responsibly managing its risks; by providing a full range of products 
and services to all customers who can responsibly manage their risks; 
and by competing against others based on price, product quality, 
reputation, and other customer interests, not by undermining standards 
of integrity. We believe it is incumbent upon policy makers to create 
the legal framework that supports these goals. 

Any regulatory reform effort must focus on solving the problems that 
caused the current market turmoil. This necessarily entails identifying 
what those problems are so that responses can be tailored accordingly. 
A business model that combines activities that are financial in nature 
and thereby draws from a diversified revenue mix has shown to be a 
solution to, and not a part of, the current problems. Thus reform 
efforts should facilitate banks offering a broad range of financial 
products and services. Conversely, reform efforts should be careful not 
merely to impose new regulations on the banking sector, which did not 
cause the crisis and which continues to provide credit; rather it 
should remove unnecessary regulations that impede sound lending and 
efficient operations. 

The current system of bank regulation and oversight has many 
advantages, and we believe any reform efforts should build on those 
advantages. As the recent rush by non-bank actors to obtain bank 
charters has demonstrated, bank regulation and supervision has proven 
to be the most durable method to minimize risks to safety and 
soundness. Moreover, it provides a useful check against any one 
regulator neglecting its duties, becoming too calcified for an ever-
changing financial marketplace, growing overly bureaucratic and 
ineffective, or otherwise imposing regulator conditions inconsistent 
with the ability of financial firms to serve their customers. Thus, the 
ABA supports the Office of the Comptroller of the Currency, Federal 
Deposit Insurance Corporation, Federal Reserve Board, and the Office of 
Thrift Supervision with regard to their diverse supervision and 
oversight responsibilities within the U.S. banking system. 

Just as there is a benefit in having multiple federal regulators, so 
too is there a benefit in having a dual banking system. States have for 
years operated as incubators for new products and services, such as NOW 
accounts and adjustable rate mortgages. The dual banking system has 
proven vital to the continued evolution of the U.S. banking. Close 
coordination between federal bank regulators and state banking 
commissioners within the Federal Financial Institutions Examination 
Council (FFIEC) as well as during joint bank examinations is a dynamic 
element of the dual banking system, resulting in a system of 
complementary supervision. 

Recent economic turmoil has drawn attention to the need for a regulator 
with explicit jurisdiction to manage systemic risk. The primary 
responsibility of systemic risk regulation should be protecting the 
economy from major shocks and working with bank supervisors to avoid 
pro-cyclical directives within the supervisory process. The systemic 
risk regulator would gather information, monitor exposures throughout 
the system and take action in concert with domestic and international 
supervisors to minimize risks to the economy. For maximum effectiveness 
and ease of implementation, systemic risk regulation should rely on 
existing regulatory structures and restrict its oversight to a limited 
number of large market participants, both bank and non-bank. 

There clearly is a need for better supervision and regulation of many 
non-bank actors, such as mortgage banks and brokers that are not 
affiliated with an insured depository institution. Consumer confidence 
in the financial sector as a whole suffers when non.-bank actors offer 
bank-like services while operating under substandard or non-existent 
guidelines for safety and soundness. Lesser-regulated companies and 
individuals participating in bank-like activities or offering bank-like 
products and services should be subject to hank-like regulation and 
capital requirements. Regulatory reform should tackle these issues and 
bring appropriate oversight to inadequately or ineffectively regulated 
financial products and services. 

This should be done within the context of agencies that have the 
authority and responsibility to supervise all aspects of an 
institution's activities. Safety and soundness issues and consumer 
protection are closely linked for banks and should be supervised as 
such. Treating consumers unfairly is inconsistent with safe and sound 
operations; so, too, is attempting to insulate consumers from any risk. 
Well-run institutions keep both facets in mind, and their regulators 
should as well. This argues in favor of continuing to place 
responsibility for both consumer protection and safety and soundness 
with the banking agencies. 

It also should be done in a manner that preserves the independence of 
the Federal Reserve Board (Board) and keeps the Board's primary focus 
on the conduct of monetary policy. Any expansion of the Board's 
authority to serve as the systemic risk regulator should be made only 
if such authority would not create conflicts of interest for the Board 
or otherwise compromise its ability to carry out its responsibilities 
for monetary policy. 

Any regulatory restructuring effort must recognize the benefits of 
charter choice. A robust banking sector requires participants of all 
sizes and business models, including community banks, development 
banks, and niche-focused financial institutions as well as regional, 
national, and international banks. Federal and state bank charter 
alternatives, a broad range of business models, as well as choice of 
ownership structure (encompassing S corporations, limited liability 
corporations, mutual ownership, and other forms of publicly-traded and 
privately-held banks) promotes responsiveness to changing customer 
needs, consumer preferences, and economic conditions. Only a diverse, 
well-regulated banking system can bring sustainable increases in 
homeownership and community development that are essential to economic 
recovery. 

This diversity is not well-served by a system that treats any financial 
institution as if it were too big or too complex to fail. Such a policy 
can have serious competitive consequences for the banking industry as a 
whole. Clear actions strengthening the competitive position of all 
banks are needed to address and ameliorate the negative effect on the 
majority of financial institutions when a select few are designated as 
too big to fail. Moreover, financial regulators should develop a 
program to identify, monitor, and respond effectively to market 
developments arising to the perception of an institution as too big or 
too complex to fail-particularly in times of financial stress. The an 
hoc approach used in the resolution of Lehman Brothers and Bear Stems 
is inadequate. Specific authorities and programs must be developed to 
manage the orderly transition or resolution of any systemically 
significant financial institution, bank or non-bank. 

Any reform effort also must address issues in our accounting rules that 
create a pro-cyclical downward drag on the financial sector and the 
economy as a whole. Accounting should be a reflection of economic 
reality, not a driver. Reforms to accounting standards should make the 
standard setting process accountable to the market and implement 
standards that consider the real-world effects of the rules. Rules 
governing loan-loss reserves and fair value accounting should minimize 
pro-cyclical effects that reinforce economic highs and lows. A reformed 
accounting system would recognize that functioning accounting rules are 
essential to minimizing systemic risk and fostering economic growth. 

Thank you for the opportunity to comment on this proposal. Should you 
have any questions, please contact the undersigned at 202-663-5333 or 
ddepierr@aba.com. 

Sincerely, 

Signed by: 

Denyette DePierro: 

[End of section] 

Appendix IV: Comments from the American Council of Life Insurers: 

ACLI: 
American Council of Life Insurers: 
Julie A. Spiezio: 
Senior Vice President, Insurance Regulation & Deputy General Counsel: 
101 Constitution Avenue, NW: 
Washington, DC 20001-2133: 
(202) 624-2194 t: 
(202) 572-4843 f: 
juliespiezio@acli.com: 
[hyperlink, http://www.acli.com] 
Financial Security For Life: 

December 15, 2008: 

Ms. Orice M. Williams: 
Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 
williamso@gao.gov: 

RE: Draft Report on Reforming the Financial Regulatory System: 

Dear Ms. Williams: 

These comments are submitted on behalf of the American Council of Life 
Insurers (ACLI). The ACLI is a national trade association with 353 
member companies that account for 93 percent of the industry's total 
assets, 93 percent of U.S. life insurance premiums and 95 percent of 
U.S. annuity considerations. We appreciate being given an opportunity 
to comment on the draft report. 

At GAO's invitation, ACLI staff undertook a brief review of the draft 
report at GAO headquarters early last week. Speaking from an insurance 
industry perspective, we were surprised that the draft report did not 
include discussion of the need for insurance regulatory reform as part 
of the broader financial services industry reform effort. We believe 
this is an important oversight and one that should be addressed before 
the final report is issued by the GAO. 

Currently there is no insurance expertise in the federal government. 
Prior to the crisis that has beset the financial service industry since 
September of this year, this fact was proving to be a costly problem 
for American consumers and insurers alike. A regulatory system that 
provides for uneven consumer protections and policy availability 
nationwide is not compatible with the economic model of the 210t 
century. In addition, the lack of a federal insurance regulatory office 
prevents the United States from adequately addressing its citizens' 
needs in international trade negotiations and treaty developments 
involving insurance industry issues. These issues alone warrant 
discussion of the need for a federal role in insurance regulation via 
the availability of an optional federal insurance charter (OFC). 

The economic crisis has only served to underscore this need. The crisis 
has highlighted for policymakers and the general public alike that 
insurers play a systemic role in our economy, both nationally and 
internationally. And today, after all that has taken place over the 
past few months, both the executive and legislative branches of the 
federal government remain handicapped in their ability to completely 
understand and respond to the underlying insurance issues that are part 
of the financial crisis because they lack any insurance industry 
regulatory expertise. 

These facts make the lack of reference to the issue of insurance 
regulatory reform in the draft GAO report just that much more puzzling. 
The report directly addresses the need for the federal government to 
assume some regulatory responsibility over other areas of the financial 
services industry where it currently lacks such authority (e.g., hedge 
funds), but remains conspicuously silent on the insurance regulatory 
reform/OFC issue. We feel this is not simply an oversight, but is a 
lost opportunity to help Congress in its effort to effectively reform 
and modernize the whole of financial services industry
regulation moving forward. 

For all of these reasons, we respectfully request that prior to the 
final publication of this GAO report it be revised to include 
discussion of the need for insurance regulatory reform. It is our 
opinion that releasing the report without such a revision will render 
the report incomplete and therefore of less value to both the Congress 
and the public at large then it otherwise might be. 

Thank you again for this opportunity to comment on the draft report. 
Please feel free to contact me directly if you have any questions or 
would like to discuss this issue further. 

Very truly yours, 

Signed by: 

Julie A. Spiezio: 

Cc: Randy Fasnacht: 
Cody Goebel: 

[End of section] 

Appendix V: Comments from the Conference of State Bank Supervisors: 

CSBS: 
Conference Of State Bank Supervisors: 
1155 Connecticut Ave., NW, 5th Floor: 
Washington DC 20036-4306: 
(202) 296-2840: 
Fax: (202) 296-1928: 

December 17, 2008: 

Orice M. Williams: 
Director: 
Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, NW: 
Washington, DC 20548: 

Dear Ms. Williams: 

Thank you for the opportunity to submit a second written comment in 
response to the GAO’s upcoming report on the financial regulatory 
framework of the United States. 

The Conference of State Bank Supervisors (CSBS) recognizes the current 
regulatory structure at both the state and federal level is sometimes 
complex for the industry, regulators, consumers, and policymakers to 
navigate. As financial institutions and service providers increase in 
size, complexity, and operations, our regulatory system must reflect 
this evolution. The current economic stresses have also shown that our 
financial regulatory system must better address the interconnected 
risks of the capital markets and our banking system. 

CSBS is committed to working with the GAO, our federal counterparts, 
Congress, industry associations, and consumer advocates to further the 
development of a fair and efficient regulatory system that provides 
sufficient consumer protection and serves the interests of financial 
institutions and financial service providers, while ultimately 
strengthening the U.S. economy as a whole. 

We believe that changes are needed in both regulation and the way our 
regulatory structure functions to better respond to consumer needs and 
address systemic risks and market integrity. We are very concerned, 
however, that federal policy that addresses nationwide and global 
regulatory business models continues to threaten—or perhaps 
eliminate—the greatest strengths of our system. Specifically, we see 
policies that promote the needs of the very largest financial 
institutions at the expense of consumers, important federal checks and 
balances and diversity of banking and other financial institutions that 
are critical to our state economies. 

The current financial regulatory structure allows for a diverse 
universe of financial institutions of varying sizes. While the 
financial industry continues to consolidate at a rapid pace, there are 
still well over 8,000 financial institutions operating within the 
United States, some of which are as small as $1 million in assets. 
Obviously, our nation’s largest money center banks play a critical role 
in the economy. However, even the smallest bank in the country is 
absolutely critical to the economic health of the community in which it 
operates. 

The complexity of the system is presented as a major source of the 
current financial crisis. While there are clearly gaps in our 
regulatory system and the system is undeniably complex, CSBS has 
observed that the greater failing of the system has been one of 
insufficient political and regulatory will, primarily at the federal 
level. We believe that decisions to consolidate regulation do not fix, 
but rather exacerbate this problem. Moreover, CSBS is deeply concerned 
that the GAO study does not fully appreciate the importance of creating 
an environment that promotes a diverse industry which serves our 
nation’s diverse communities and avoids a concentration of economic and 
political power in a handful of institutions. 

Specifically, we are offering the following comments to the elements of 
a successful supervisory framework. 

Clearly Defined Regulatory Goals: 

Generally, we agree with the GAO’s goals of a regulatory system that 
ensures adequate consumer protections, ensures the integrity and 
fairness of markets, monitors the safety and soundness of institutions, 
and acts to ensure the stability of the overall financial system. We 
disagree, however, with the GAO’s claim that the safety and soundness 
goal is necessarily in direct conflict with the goal of consumer 
protection. It has been the experience of state regulators that the 
very opposite can be true. Indeed, consumer protection should be 
recognized as integral to safety and soundness of financial 
institutions and service providers. The health of a financial 
institution ultimately is connected to the health of its customers. 
However, we have observed that federal regulators, without the checks 
and balances of more locally responsive state regulators or state law 
enforcement do not always give fair weight to consumer issues or have 
the perspective to understand consumer issues. We consider this a 
significant weakness of the current system. Federal preemption of state 
law and state law enforcement by the Office of the Comptroller of the 
Currency and the Office of Thrift Supervision has resulted in less 
responsive consumer protections and institutions that are much less 
responsive to needs of consumers in our states. 

Appropriately Comprehensive: 

CSBS disagrees that federal regulators were unable to identify the 
risks to the financial system because they did not have the necessary 
scope of oversight. As previously noted, we believe it was a failure of 
regulatory will and a philosophy of self-regulating markets that 
allowed for risks to develop. CSBS strongly believes a “comprehensive” 
system of regulation should not be construed as a consolidated regime 
under one single regulator. Instead, “comprehensive” should describe a 
regulatory system that is able to adequately supervise a broad, 
diverse, and dynamic financial industry. We believe that the checks and 
balances of the dual system of federal and state supervision are more 
likely to result in comprehensive and meaningful coverage of the 
industry. From a safety and soundness perspective and from a consumer 
protection standpoint, the public is better served by a coordinated 
regulatory network that benefits from both the federal and state 
perspectives. We believe the Federal Financial Institutions Examination 
Council (FFIEC) could be much better utilized to accomplish this 
approach. 

Systemwide Focus: 

The GAO report states “a regulatory system should include a mechanism 
for identifying, monitoring, and managing risks to the financial system 
regardless of the source of the risk or the institutions in which it 
was created.” CSBS agrees with this assessment. Our current crisis has 
shown us that our regulatory structure was incapable of effectively 
managing and regulating the nation’s largest institutions. CSBS 
believes the solution, however, is not to expand the federal government 
bureaucracy by creating a new super regulator. Instead, we should 
enhance coordination and cooperation among the federal government and 
the states. We believe regulators must pool resources and expertise to 
better manage systemic risk. The FFIEC provides a vehicle for working 
towards this goal of seamless federal and state cooperative 
supervision. 

In addition, CSBS provides significant coordination among the states as 
well as with federal regulators. This coordinating role reached new 
levels when Congress adopted the Riegle-Neil Act to allow for 
interstate banking and branching. The states, through CSBS, quickly 
followed suit by developing the Nationwide Cooperative Agreement and 
the State-Federal Supervisory Agreement for the supervision of multi-
state banks. Most recently, the states launched the Nationwide Mortgage 
Licensing System (NMLS) and a nationwide protocol for mortgage 
supervision. Further, the NMLS is the foundation for the recently 
enacted Secure and Fair Enforcement for Mortgage Licensing Act of 2008, 
or the S.A.F.E. Act. The S.A.F.E. Act establishes minimum mortgage 
licensing standards and a coordinated network of state and federal 
mortgage supervision. 

Flexible and Adaptable: 

CSBS agrees that a regulatory system should be adaptable and forward-
looking so that regulators can readily adapt to market innovations and 
chances to include a mechanism for evaluating potential new risks to 
the system. In fact, this is one of the greatest strengths of the state 
system. The traditional dynamic of the dual-banking system of 
regulation has been that the states experiment with new products, 
services, and practices that, upon successful implementation, Congress 
later enacts on a nationwide basis. In addition, state bank examiners 
are often the first to identify and address economic problems. Often, 
states are the first responders to almost any problem in the financial 
system. The states can—and do—respond to these problems much more 
quickly than the federal government as evidenced by escalating state 
responses to the excesses and abuses of mortgage lending over the past 
decade. Unfortunately, the federal response was to thwart rather than 
encourage these policy responses. 

Efficient and Effective: 

In the report, GAO asserts that a system should provide for efficient 
and effective oversight by eliminating overlapping federal regulatory 
missions and minimizing regulatory burden. CSBS believes efficiency 
must not be achieved at the cost of protecting consumers, providing for 
a competitive industry that serves all communities or maintaining the 
safety and soundness of financial institutions. We recognize that our 
regulatory structure is complex and may not be as efficient as some in 
the industry would prefer. There is undoubtedly a need for improved 
coordination and cooperation among functional regulators. However, this 
efficiency must not be met through the haphazard consolidation or 
destruction of supervisory agencies and authorities. CSBS strongly 
believes that it is more important to preserve a regulatory framework 
with checks and balances among and between regulators. This overlap 
does not need to be a negative characteristic of our system. Instead, 
it has most often offered additional protection for our consumers and 
institutions. We believe that the weakening of these overlays in recent 
years weakened our system and contributed to the current crisis. 

In addition, we should consider how “efficient” is defined. Efficient 
does not inherently mean effective. Our ideal regulatory structure 
should balance what is efficient for large and small institutions as 
well as what is efficient for consumers and our economy. While a 
centralized and consolidated regulatory system may look efficient on 
paper or benefit our largest institutions, the outcomes may be 
inflexible and be geared solely at the largest banks at the expense of 
the small community institutions, the consumer or our diverse economy. 

Consistent Consumer and Investor Protection: 

The states have long been regarded as leaders in the consumer 
protection arena. This is an area where the model of states acting as 
laboratories of innovation is clearly working. State authorities often 
discover troubling practices, trends, or warning signs before the 
federal agencies can identify these emerging concerns. State 
authorities and legislature then are able to respond quickly to protect 
consumers. Ultimately, Congress and federal regulators can then rely on 
state experience to develop uniform and nationwide standards or best 
practices. Ultimately, we believe the federal government is simply not 
able to respond quickly enough to emerging threats and consumer 
protection issues. State authorities have also been frustrated by 
federal preemption of state consumer protection laws. If Congress were 
to act to repeal or more clearly limit these preemptions, states would 
be able to more effectively and consistently enforce consumer 
protection laws. 

CSBS also agrees that there were significant loopholes and unequal 
regulation and examination of the mortgage industry. In fact, the 
states led the way to address these regulatory gaps. However, in 
describing where subprime lending occurred, we believe the report 
should acknowledge the fact that subprime lending took place in nearly 
equal parts between nonbank lenders and institutions subject to federal 
bank regulation. Federal regulation of operating subsidiaries has been 
inconsistent at best and nonexistent at worst. As acknowledged in the 
report, affiliate regulation for consumer compliance simply did not 
exist at the federal level until a recent pilot project led by the 
Federal Reserve was initiated. 

The report also fails to acknowledge the very significant reforms of 
mortgage regulation adopted by Congress under the S.A.F.E. Act or the 
major efforts the states have engaged in to regulate the nonbank 
mortgage lenders and originators. 

Regulators Provided with Independence, Prominence, Authority, and 
Accountability: 

The dual-banking system helps preserve both regulator independence and 
accountability. The state system of chartering, with an independent 
primary federal regulator probably serves as the best model for this 
goal. 

Consistent Financial Oversight: 

Consistency in regulation is important, but our financial system must 
also be flexible enough to allow our diverse institutions all to 
flourish. The diversity of our nation’s banking system has created the 
most dynamic and powerful economy in the world, regardless of the 
current problems we are experiencing. The strength at the core of our 
banking system is that it is comprised of thousands of financial 
intuitions of vastly different sizes. Even as our largest banks are 
struggling to survive, the vast majority of community banks remains 
strong and continues to provide financial services to their local 
citizens. It is vital that a one-size-fits-all regulatory system does 
not adversely affect the industry by putting smaller banks at a 
competitive disadvantage with larger, more complex institutions. 

It is our belief that the report should acknowledge the role of federal 
preemption of state consumer protections and the lack of responsiveness 
of federal law and regulation to mortgage lending and consumer 
protection issues. For example, the states began responding in 1999 to 
circumventions of HOEPA and consumer abuses related to subprime 
lending. Nine years later and two years into a nationwide subprime 
crisis and Congress has not yet been able to adopt a predatory lending 
law. We believe that some industry advocates have pushed for preemption 
to prevent the states from being able to develop legislative and 
regulatory models for consumer protection and because they have been 
successful in thwarting legislation and significant regulation at the 
federal level. 

Minimal Taxpayer Exposure: 

CSBS strongly agrees that a regulatory system should have adequate 
safeguards that allow financial institution failures to occur while 
limiting taxpayers’ exposure to financial risk. Part of this process 
must be to prevent institutions from becoming “too big to fail,” “too 
systemic to fail,” or simply too big to regulate. Specifically, the 
federal government must have regulatory tools in place to manage the 
orderly failure of the largest institutions rather than continuing to 
prop up failed systemic institutions. 

CSBS Principles of Regulatory Reform: 

While numerous proposals will be advanced to overhaul the financial 
regulatory system, CSBS believes the structure of the regulatory system 
should: 

1. Usher in a new era of cooperative federalism, recognizing the rights 
of states to protect consumers and reaffirming the state role in 
chartering and supervising financial institutions. 

2. Foster supervision that is tailored to the size, scope, and 
complexity of the institution and the risk they pose to the financial 
system.
3. Assure the promulgation and enforcement of consumer protection 
standards that are applicable to both state and nationally chartered 
financial institutions and are enforceable by locally-responsive state 
officials against all such institutions. 

4. Encourage a diverse universe of financial institutions as a method 
of reducing risk to the system, encouraging competition, furthering 
innovation, insuring access to financial markets, and promoting 
efficient allocation of credit. 

5. Support community and regional banks, which provide relationship 
lending and fuel local economic development. 

6. Require financial institutions that are recipients of governmental 
protection or pose systemic risk to be subject to safety and soundness 
and consumer protection oversight. 

The states, through CSBS and the State Liaison Committee’s involvement 
on the FFIEC, will be part of any solution to regulatory restructuring 
or our current economic condition. We want to ensure consumers are 
protected, and preserve the viability of both the federal and state 
charter to ensure the success of our dual-banking system and our 
economy as a whole. 

CSBS believes there is significant work to be done on this issue, and 
we commend the GAO for undertaking this report. 

Best regards, 

Signed by: 

John W. Ryan: 
Executive Vice President: 

[End of section] 

Appendix VI: Comments from Consumers Union: 

Consumers Union: 
West Coast Office: 
1535 Mission Street: 
San Francisco, CA 94104: 
tel: 415.431.6747: 
fax: 415.431.0906: 
[hyperlink, http://www.consumersunion.org] 

Via Electronic Mail: 

December 16, 2008: 

Ms. Orice M. Williams: 
Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, DC 20548: 

Re: GAO Report on Reforming the Financial Regulatory System: 

Dear Ms. Williams: 

Consumers Union, the nonprofit publisher of Consumer Reports, is deeply 
interested in creating a more effective structure for the regulation of 
financial institutions and other participants in the financial markets. 
Financial regulation must be designed to protect individuals as 
consumers of credit and deposit services, as investors, and as 
taxpayers. 

The spark for the financial crisis was unsuitable, poorly underwritten 
loans being sold to individual homeowners. The risk was amplified by 
widespread sale of financial instruments based on those mortgages. The 
resulting crisis of confidence has led to reduced credibility for the 
U.S. financial system, gridlocked credit markets, loss of equity for 
homeowners who accepted subprime mortgages and for their neighbors who 
did not, empty houses and reduced property tax revenue. 

Any future financial regulatory structure must include active federal 
and state oversight, a priority on consumer protection, steps to make 
the pricing and features of financial products less complex, and more 
accountability by financial entities at each step of a financial 
transaction. 

1. Regulators must be required to proactively monitor new products and 
practices to address dangers before they spread. 
Financial system regulators must identify, evaluate, and mitigate 
emerging risks both to the financial system and to individuals. 
Regulators must abandon the old "wait and see" regulatory approach, 
where a problem has to grow to be national in scope, and perhaps be in 
the public eye, before it is addressed. Financial regulators must have 
independence from the entities they oversee and an express charge to 
regulate for the prevention of harm both to individuals and to the 
financial system. 

2. Financial system regulators should give the same priority to 
consumer protection as to safety and soundness. 
The mortgage crisis and its aftermath dramatically illustrate that the 
consumer protection and safety and soundness are inextricably linked. 
Regulators must increase the priority placed on consumer protection. 

3. Practices and features that make financial products sold to 
individuals too complex to understand must be stopped. 
The report speaks in several places about the need for financial 
literacy or improved disclosure. However, financial products which are 
too complex for the intended consumer carry special risks that no 
amount of additional disclosure or information will fix. In subprime 
mortgages, for example, many homeowners were induced to refinance an 
existing loan for one that would offer a reduced payment for just the 
first two years. Others were assured that they could refinance later, 
yet the loan documents contained an expensive prepayment penalty. Many 
of the tens of thousands of individuals who filed comments in the 
Federal Reserve Board's Regulation AA docket on unfair or deceptive 
credit card practices reported that they learned about harmful card 
issuer practices apparently permitted by the cardholder agreement only 
when the practice was first invoked against them. Regulatory reform 
will be incomplete unless regulators identify and stop practices that 
make credit and deposit products difficult for individuals to 
understand and evaluate. 

4. Federal and state regulatory diversity is essential to robust 
oversight. 
We agree with report that it is important to eliminate the bottlenecks 
that can be caused by the coordination process between multiple federal 
regulators. However, no single federal agency leader can foresee all of 
the consequences of new practices and products. For this reason, 
Consumers Union supports both an independent federal consumer 
protection agency for financial services products (with concurrent 
jurisdiction with existing banking agencies), and the power of states 
to develop and enforce consumer protections. The swift and troubling 
developments in the financial meltdown show that we cannot rely on a 
single federal agency leader to anticipate all of the risks in new 
practices and products, nor to have the inclination or the resources to 
pursue all of the areas where law enforcement is needed. 

5. Accountability must be built into the financial system. 
During the build-up to the crisis, loan originators and securitization 
packagers got fees even if loans couldn't later be repaid. Regulatory 
restructuring should include changing the incentives in the private 
market by requiring that everyone who gets a fee in connection with a 
credit product also keeps some of the risk of future nonpayment and the 
risk of problems with the loan. In addition, everyone who offers 
financial products to consumers should be subject to suitability 
requirements and fiduciary duties. 

We appreciate the work of the GAO in this important issue area. 
Creating a strong, trusted regulatory structure for financial products 
and the financial markets is essential to rebuilding the public 
confidence in the U.S. financial markets. 

Very truly yours, 

Signed by: 

Gail Hillebrand: 
Financial Services Campaign Manager: 
Consumers Union of U.S., Inc. 

[End of section] 

Appendix VII: Comments from the Credit Union National Association: 

CUNA: 
Credit Union National Association: 
601 Pennsylvania Ave., NW: 
South Building, Suite 600: 
Washington, DC 20004-2601: 
Phone: 202-638-5777: 
Fax: 202-638-7734: 
[hyperlink, http://www.cuna.org] 

December 18, 2008: 

Mr. Cody Goebel: 
Assistant Director: 
Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, NW, Room 2440B: 
Washington, DC 20548: 

Dear Mr. Goebel: 

On behalf of the Credit Union National Association, thank you for the 
opportunity Bill Hampel, Ryan Donovan, and I had December 12, 2008 to 
review the Government Accountability Office's draft report on 
restructuring the financial regulatory system. CUNA is the largest 
advocacy organization representing the nation's 8,200 state and federal 
credit unions, which serve approximately 91 million members. 

The report's treatment of credit unions is understandably abbreviated, 
given the fact that credit unions were not the cause of the financial 
market meltdown --although a limited number have experienced serious 
collateral effects. In line with GAO's approach, our letter focuses 
only on the independence of the National Credit Union Administration 
Board. 

Unlike the Treasury's "Blueprint for Financial Modernization," which 
reflects a complete disregard for and lack of understanding of credit 
unions, the GAO draft stops short of offering specific recommendations. 
Even so, the report indicates there is merit to consideration of 
regulatory consolidation for certain purposes, such as consumer 
protection, and to address threats to the overall stability of the 
financial system. While we recognize the factors that support such 
consideration and appreciate that with four federal bank regulators, 
some consolidation there may be appropriate, we would strongly oppose 
any efforts to combine NCUA or its insurance function with another 
agency, as addressed below. 

The draft report sets out several defined goals for an appropriate 
regulatory system, which include: a comprehensive approach to 
regulation that is system wide, flexible, efficient, and independent 
while providing consistent consumer protection and financial oversight. 

CUNA likewise supports these objectives, which we believe are wholly 
consistent with the continuation of a separate regulator for credit 
unions. Earlier this month, CUNA's Governmental Affairs Committee 
reaffirmed strong support for a distinct federal regulator as long as 
it provides rigorous, effective supervision that enhances their 
financial strength and is well-tailored to the level of risk credit 
unions demonstrate. At the same time, credit unions need and deserve a 
regulator that will facilitate, not stymie, their capabilities to 
provide innovative yet safe services to their consumer-members at 
favorable rates. While urging NCUA's independence, credit unions also 
appreciate the need for the agencies to address certain issues 
collectively, and to that end CUNA has recommended NCUA be included in 
the Presidential Working Group, which is currently comprised of the 
banking regulators but not NCUA. 

Another goal the GAO draft includes is to minimize taxpayers' exposure 
in the event problems arise. To that end, the credit union regulatory 
structure combines the enforcement of demanding safety and soundness 
standards under NCUA's prompt corrective action provisions with an 
approach that seeks to contain credit union problems within the system. 
Virtually all of the funds to operate NCUA and the NCUSIF are provided 
by the credit union system, without reliance on taxpayer dollars, and 
since its inception in 1978, the NCUSIF has achieved a commendable 
record in managing problem cases and avoiding taxpayer losses. Another 
example of credit unions' self-sustaining efforts is their advocacy for 
the use of NCUSIF funds to purchase troubled assets from the limited 
number of natural person credit unions that might need such assistance 
first, before seeking back-up assistance from the Treasury's Troubled 
Asset Relief Program. 

For many credit unions, maintaining a separate regulator is critical to 
their preservation as institutions with fundamentally different 
motivations than other financial intermediaries have. Credit unions are 
operated by volunteer boards who do not receive economic inducements to 
serve but rather serve to meet the financial needs of their member-
owners. Banks are motivated by the need to reward their stockholders 
first, and then their customers. Because of these core differences, 
only a separate, effective regulator will provide the singular focus 
necessary to further credit unions' distinctiveness, thereby ensuring 
consumers will continue to have choices in the financial marketplace. 

Again, thank you for the opportunity to provide these comments 
following the review of your draft. Please do not hesitate to contact 
any one of us if you have questions about credit unions or this letter. 
All the best for happy holidays. 

Sincerely, 

Signed by: 

Mary Mitchell Dunn: 
CUNA Deputy General Counsel and Senior Vice President: 

[End of section] 

Appendix VIII: Comments from the Federal Deposit Insurance Corporation: 

FDIC: 
Federal Deposit Insurance Corporation: 
Division of Supervision and Consumer Protection: 
550 17th Street NW: 
Washington, D.C. 20429-9990: 

December 10, 2008: 

Ms. Orice M. Williams: 
Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 

Dear Ms. Williams: 

The FDIC appreciates the opportunity to provide comments on the GAO's 
report titled Financial Regulation: A Framework for Crafting and 
Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory 
System. We understand that this report is self-initiated, and is 
intended to provide a set of principles by which policymakers can 
evaluate various proposals to restructure the U.S. financial regulatory 
system. We commend the GAO for undertaking this important project. 

As an overarching premise, the report states that the U.S. financial 
regulatory structure is in need of modernization. The FDIC agrees that 
effective reform of the U.S. financial regulatory system would help 
avoid a recurrence of the economic and financial problems we are now 
experiencing. 

As we consider recent experience, two issues related to U.S. financial 
regulatory performance stand out to us as being of particular concern. 
First, our regulatory structure collectively did not address a 
systematic breakdown in lending standards in wide segments of the U.S. 
mortgage market. An important lesson that should be incorporated in any 
regulatory reform proposal is that irresponsible or abusive lending 
practices are consistent neither with safe-and-sound banking nor with 
sustainable economic growth. 

Second, the regulatory structure collectively permitted excessive 
leverage in the non-bank financial system. Facing no explicit leverage 
constraints, and lulled by quantitative models and agency ratings into 
believing risks were minimal, a variety of large investment banks, 
financial guarantee insurers and hedge funds operated with a degree of 
leverage that significantly diminished their ability to withstand 
financial stress. An important lesson from recent years is that 
unconstrained leverage places not only individual firms at risk, but 
greatly increases the severity of financial market downturns and 
imposes significant costs on taxpayers. 

These two issues were not addressed as effectively as they should have 
been, in part because of regulatory gaps, and in part because of 
regulatory choices about how to exercise existing authority. Thus, 
while the role of regulatory structure is an important part of 
improving regulatory performance, statutory mandates for the regulators 
are of equal importance. Existing prompt corrective action law is a 
good example of a successful mandate. Any regulatory reform proposal 
should include consideration of appropriate mandates in the area of 
consumer protection. For example, some lending practices can be so 
egregious as to warrant their outright prohibition, as opposed to 
placing sole reliance on promoting financial literacy or improving 
disclosures. Regulatory reform proposals should also consider statutory 
mandates for leverage constraints for non-bank financial firms, and 
well-defined mechanisms to protect taxpayers from the cost of financial 
bailouts. 

We believe the experience of recent years strongly supports the 
importance of an independent FDIC with the resources and authority to 
safeguard the government's financial stake in federal deposit insurance 
and promote public confidence in the banking system. The FDIC's 
independent perspective has been evidenced in recent years by its 
actions addressing both individual troubled financial institutions and 
systemic risk, strengthening our deposit insurance system, ensuring 
capital safeguards in the implementation of Basel II's advanced 
approaches, and promoting confidence in the banking system by promoting 
financial literacy, educating consumers about deposit insurance and 
taking actions to protect consumers. 

Thank you once again for the opportunity to comment on this report. As 
always, we have appreciated the professionalism with which the GAO's 
review team conducted this assignment. 

Sincerely, 

Signed by: 

Sandra L. Thompson: 
Director: 

[End of section] 

Appendix IX: Comments from the Mortgage Bankers Association: 

Mortgage Bankers Association: 
"Investing In Communities" 

December 18, 2008: 

Ms. Orice M. Williams: 
Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 

Dear Ms. Williams: 

The Mortgage Bankers Association greatly appreciates the opportunity to 
comment on the forthcoming report of the United States Government 
Accountability Office entitled "Financial Regulation: A Framework for 
Crafting and Assessing Proposals to Modernize the Outdated U.S. 
Regulatory System." MBA strongly supports the improvement of the 
regulatory requirements and the regulatory structure for mortgage 
lending and commends GAO’s efforts in this vital area. 

MBA’s main comments are that the report should recognize that: (1) 
responsibility for the current financial crisis is diffuse; (2) 
solutions recommended for the lending sphere should include 
consideration of a uniform mortgage lending standard that is preemptive 
of state lending standards; and (3) federal regulation of at least 
independent mortgage bankers deserves discussion. 

In MBA’s view, the factors contributing to the current crisis are 
manifold. They include, but are not limited to, traditional factors 
such as unemployment and family difficulties, high real estate prices 
and overbuilding, extraordinary appetites for returns, lowering of 
lending standards to satisfy investor and borrower needs, the growth of 
unregulated and lightly regulated entities and, to some degree, 
borrower misjudgment and even fraud. 

In MBA’s view no single actor or actors can fairly be assigned sole or 
even predominant blame for where we are today. On the other hand, MBA 
strongly believes that all of these factors contributing to the crisis 
deserve review as we fashion regulatory solutions. Specifically, 
respecting mortgage lending, MBA believes that the crisis presents an 
unparalleled opportunity to reevaluate the current regulatory 
requirements and structure for mortgage lending to protect the nation 
going forward. 

MBA has long supported establishment of a uniform national mortgage 
lending standard that establishes strong federal protections, preempts 
the web of state laws and updates and expands federal requirements. 
Currently, lending is governed, and consumers are protected by, a 
patchwork of more than 30 different state laws which are piled on top 
of federal requirements. Some state laws are overly intrusive and some 
are weak. The federal requirements in some cases are duplicative and in 
some areas are out-of-date. In some states, there are no lending laws 
and borrowers have little protection beyond federal requirements. 

MBA believes legislators should look at the most effective state and 
federal approaches and work with stakeholders to fashion a new uniform 
standard which is appropriately up-to-date, robust, applies to every 
lender, and protects every borrower. It should be enacted by the 
Congress and preempt state laws. A uniform standard would help restore 
investor confidence and be the most effective and least costly means of 
protecting consumers against lending abuses nationwide. Having one 
standard would avoid undue compliance costs, facilitate competition and 
ultimately decrease consumer costs. 

MBA recognizes that one of the key objections to a preemptive national 
standard is that it would not be flexible and adaptable and preclude 
state responses to future abuse. MBA believes this problem is 
surmountable and could be resolved by injecting dynamism into the law. 
One approach would be to supplement the law as needed going forward 
with new prohibitions and requirements formulated by federal and state 
officials in consultation. 

Currently, some mortgage lenders are regulated as federal depository 
institutions, some as state depositories and some as state-regulated 
non-depositories. MBA believes that along with establishment of a 
uniform standard, a new federal regulator for independent mortgage 
bankers and mortgage brokers should be considered and MBA is interested 
in exploring that possibility. 

A new regulator should have sufficient authorities to assure prudent 
operations to address financing needs of consumers. If such an approach 
is adopted, states also could maintain a partnership with the federal 
regulator in examination, enforcement and licensing. MBA believes the 
combined efforts of state and federal officials in regulatory reviews 
and enforcement under a uniform standard would greatly increase 
regulatory effectiveness and focus. 

Notably, any new regulatory scheme should address the differing 
regulatory concerns presented by mortgage bankers and by mortgage 
brokers, considering their differing functions and the differing policy 
concerns which the respective industries present. MBA has written 
extensively on this subject and commends to GAO’s attention the 
attached report entitled Mortgage Bankers and Mortgage Brokers: 
Distinct Businesses Warranting Distinct Regulation (2008). 

Again, MBA strongly believes today’s financial difficulties present an 
unparalleled opportunity to establish better regulation in the years to 
come. Today’s financial crisis reminds us daily that financial markets 
are national and international in scope. As the crisis worsened, the 
world looked to national and international governments for solutions. 
MBA believes it would be unwise not to use this moment to establish a 
national standard and cease dispersing regulatory responsibility, to 
help prevent crises ahead. 

Thank you again for the opportunity to comment. 

Sincerely, 

Signed by: 
John A. Courson: 
Chief Operating Officer: 
Mortgage Bankers Association: 

[End of section] 

Appendix X: Comments from the National Association of Federal Credit 
Unions: 

NAFCU: 
National Association of Federal Credit Unions: 
3138 10th Street North: 
Arlington, VA 22201-2149: 
(703) 522-4770: 
(800) 336-4644: 
Fax (703) 524-1082: 
[hyperlink, http://www.nafcu.org] 
nafc@nafcu.org: 

December 15, 2008: 

Orice M. Williams: 
Director: 
Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, NW: 
Washington, D.C. 20548: 

RE: Report of the U.S. Government Accountability Office on the 
Financial Markets and Financial Regulatory Structure: 

Dear Ms. Williams: 

On behalf of the National Association of Federal Credit Unions (NAFCU), 
the only trade association that exclusively represents the interests of 
our nation's federal credit unions (FCUs), I am providing the following 
comments regarding the upcoming report by the U.S. Government 
Accountability Office (GAO) regarding the state of the financial 
industry and the regulatory structure. 

NAFCU would first like to express our appreciation for the opportunity 
to meet with GAO staff and to review the draft GAO Report. As a trade 
association that represents federal credit unions, which are uniquely 
structured to provide provident thrift at lower cost to persons whom 
they arc chartered to serve, we believe we provide unique and specific 
insight regarding the crisis in the financial sector and the regulatory 
structure under which financial institutions operate. We applaud the 
GAO for preparing a well written draft Report. We would like, however, 
to use this opportunity to provide the following specific comments and 
suggestions. 

References to Credit Unions: 

The draft Report references comprehensive regulations to which "some 
institutions, such as banks ..." are subject. To ensure that readers of 
the Report do not misunderstand, we request the Report adds "credit 
unions." We specifically ask that the phrase "credit unions" is added 
in the following places of the draft report: (1) page 5 after "For 
example, some institutions, such as banks"; (2) page 8, line 1 after 
the word "banks"; and (3) on page 23, in the first full paragraph, add 
"credit unions" after "banks" and before "broker-dealers." 

Also, we ask that the phrase "non-credit union" is added after "non-
bank" on page 17, Figure 2. Similarly, "non-credit unions" should 
follow "non-banks" on page 23 in the subheading that presently reads 
"Activities of NonBank Mortgage Lenders Played A Significant Role." As 
you are aware, the non-banks referenced in the figure are also non-
credit unions. As such, we believe the figure would be clearer if it 
more clearly explains that the non-banks are also not credit unions. 

Framework for Regulatory Restructuring: 

A key aspect of the draft report is the provision of nine elements as a 
framework to restructure the financial regulatory system. While we 
believe the framework contains sound ideas, we strongly recommend that 
you fully incorporate the need to ensure that smaller institutions, 
particularly credit unions, are not inadvertently overlooked in any 
restructuring that Congress may institute. 

We are particularly concerned about Element Two and Element Eight. 
Element Two recommends a single "market stability regulator." Element 
Eight recommends consistent financial oversight. As we have previously 
expressed to GAO staff, we believe an independent regulator should 
continue to oversee and examine federal credit unions. The distinctive 
characteristics of federal credit unions, including their cooperative 
structure and mission to provide provident service at lower cost to 
those they are chartered to serve, necessitates that they are regulated 
by an independent entity. Accordingly, we request that these two 
elements are revised to reflect the need of an independent regulator 
for federal credit unions. 

NAFCU appreciates this opportunity to share its comments on this 
interim rule. Should you have any questions or require additional 
information please call me at (703) 522-4770 or (800) 336-4644 ext. 
268. 

Sincerely, 

Signed by: 

Tessema Tefferi: 
Associate Director of Regulatory Affairs: 

[End of section] 

Appendix XI Comments from the Center for Responsible Lending, the 
National Consumer Law Center, and the U.S. PIRG: 

December 16, 2008: 

Via Email And U.S. Mail: 

Ms. Orice M. Williams (williamso@gao.gov): 
Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 

with copies via email to: 

Mr. Cody Goebel, Assistant Director (goebelc@gao.gov): 
Mr. Randall Fasnacht (fasnachtr@gao.gov): 

Re: Comments on Draft Report, GAO-09-216: 

Dear Ms. Williams: 

We appreciate the opportunity to review the draft report at your 
offices on December 4, and to offer comments. These are offered jointly 
by CRL, the National Consumer Law Center and USPIRG. 

The report is a thoughtful and thorough review of the structural issues 
regarding regulatory reform. We especially appreciate that your report 
notes the problem of charter competition and the distorting impact of 
the funding structure for the banking regulators. 

We would like to preface our comments by stating the obvious – that 
this review does not occur in a vacuum, but rather in the context of a 
major crisis which exposed fundamental weaknesses on many fronts. The 
structural problems in the federal regulator system are but one. Some 
of these comments derive not from the specific content of the report, 
but the messages conveyed by some of the references to other aspects of 
the crisis, such as the nature of the market and consumer behavior. 
Another especially important comment derives as much from what is left 
unsaid. Perhaps it seems as though it should go without saying, but 
given much of the debate that this crisis has engendered, we fear that 
without at least an acknowledgement of what is not addressed by your 
report, necessary reminders of other integral parts of regulatory 
reform may be lost. 

While the structure of regulation can create its own problems, such as 
the potential for charter competition and regulatory capture that you 
note, regulators also need tools (in the form of laws to enforce, or 
directives to promulgate rules in furtherance of such laws), adequate 
resources and, above all, the will to regulate. No amount of structural 
reform will succeed if regulators have no charge to fulfill in their 
job, nor the will to do so. We have had three decades of a deregulatory 
agenda, and without a change in that overarching view, structural 
changes will be insufficient. We recognize that the prevailing 
philosophy of regulation was not the focus of this report. However, we 
believe that any discussion of regulatory structural reform must be 
accompanied by an explicit caveat that it addresses only one aspect of 
the overall regulatory issues that contributed to this crisis, and that 
changing the structure, alone, will be insufficient if these other 
necessary conditions for effective oversight are not reformed, as well. 

Beyond that overarching context for regulatory reform, we offer the 
following comments. 

1. The best way to avoid systemic risk is to address problems that 
exist at the level of individual consumer transactions, before they 
pose a threat to the system as a whole. 

The report appropriately addresses the need to effectively monitor and 
regulate problems that threaten the financial system as a whole. 
However, the most effective way to address systemic risk is to identify 
market failures that threaten abuse of individual consumers, and to 
address these failures before they threaten the system as a whole. The 
crisis today would not have reached its current state had problems been 
addressed and prevented before they evolved into the foreclosure 
epidemic now underway. 

The report correctly notes that most subprime lending was done by 
nonbank lenders who were not subject to oversight by the federal 
banking agencies.[Footnote 78] However, the market failures that 
contributed to the current crisis are not limited to the subprime 
market. The failure of the Alt-A market, including poorly underwritten 
non-traditional loans, are also significant contributors, as is 
becoming increasingly apparent. The failures of IndyMac and Washington 
Mutual, among others, are largely the function of overly aggressive 
lending of risky products that were unsuitable for far too many 
borrowers, and these did occur under the watch of the federal banking 
agencies. Though the federal banking agencies issued some guidelines 
for nontraditional lending, it was too little and too late. Further, to 
judge from the performance of the late vintages of these loans, even 
then, they were insufficiently enforced. 

But in any case, neither bank nor nonbank lenders were subject to 
adequate consumer protection laws. Both banks and non-bank lenders 
pressed legislators and regulators not to enact such protections. 
Furthermore, banks subject to federal regulation also contributed to 
the problem by being part of the secondary market’s demand for the 
risky products that permeated the subprime and Alt-A markets.[Footnote 
79] The report should make clear that to adequately protect consumers, 
and avoid systemic risk in the future, whatever regulatory structure 
emerges will need to be more robust and effective in protecting 
consumers than the current system has been to date. 

2. To effectively protect consumers the regulatory system must prohibit 
unsustainable lending; disclosures and “financial literacy” are not 
enough. 

The fundamental problem at the heart of today’s crisis is that loan 
originators pushed borrowers into loan products that were inherently 
risky and unsustainable by design, and they did so notwithstanding the 
availability of the more suitable and affordable loans for which they 
qualified.[Footnote 80] The most common product in the subprime market 
in recent years was not merely an adjustable rate mortgage, but rather 
an adjustable rate mortgage with built-in payment shock that lenders 
anticipated most borrowers could not afford, but that they could avoid 
only by refinancing before the payment shock took effect, typically 
paying typically 3% to 4% of the loan balance as a “prepayment penalty” 
in order to refinance. 

According to a Wall Street Journal study, 55% of the borrowers who 
received such loans in 2005, and 60% of those who received them in 
2006, had credit scores high enough to have qualified for lower cost 
prime loans.[Footnote 81] And even those borrowers who did not qualify 
for prime could have had 30-year fixed rate loans for approximately 65 
basis points above the introductory rate on the loans they received. 
[Footnote 82] The report suggests incorrectly (pp. 43-44) that subprime 
loans “help[] borrowers afford houses” they could not otherwise afford, 
when in fact, most subprime loans refinanced existing loans, rather 
than purchased new homes.[Footnote 83] But in either case, had 
borrowers been offered the more suitable loans for which many 
qualified, many more borrowers could have sustained homeownership. 
[Footnote 84] 

The experience with the recent vintages of Alt-A loans are similarly 
instructive. Chris Ferrell, an economics editor with the NPR program 
Marketplace referred to the Payment Option ARM product (many of which 
are Alt-A) as “the most complicated mortgage product ever marketed to 
consumers.” The greater the complexity, the less suitable that 
disclosure is as a “market perfecting” tool. Further, the huge jump in 
payment option ARMS, (from $145 billion to $255 billion from 2004-
2007), was primarily possible only by the increasingly poor 
underwriting. Countrywide, one of the major issuers of these loans 
(that issued them under both its national bank and federal thrift 
charters, as well as some of its non-depository entities) admitted that 
an estimated 80% of its recent POARMs would not meet the late 2006 
federal guidelines.[Footnote 85] 

The Federal Reserve has noted that, given the misaligned incentives of 
originators and the complexity of products and loan features, even with 
increased information or knowledge, borrowers could not have defended 
against poorly underwritten, risky products and deceptive practices. 
The main problem with these loans was not the inadequacy of the 
disclosures or the financial literacy of the borrowers. Rather, the 
fundamental problem was that – as the federal banking regulators 
belatedly recognized with respect to non-traditional loans in late 2006 
and subprime lending in 2007 -- lenders should not have made loans that 
they knew borrowers would be unable to sustain without refinancing. 

3. To effectively protect consumers, the regulatory system must monitor 
and address market incentives that encourage loan originators to push 
risky or unsuitable loan products. 

The report correctly notes that market incentives encouraged loan 
originators to extend excessive credit (p. 22). It should also note 
that these same incentives encouraged them to push riskier productions 
and features than the borrowers qualified for.[Footnote 86] The report 
should note the need for regulatory oversight of market failures that 
reward market participants for irresponsible behavior. 

We understand that philosophies of consumer protection and the adequacy 
of consumer protection laws is not your intended focus. However, there 
were occasional statements in the report which, intended or not, seemed 
to convey a message that improved disclosure or literacy would be 
adequate. Yet more people – including some of the regulators themselves 
– are recognizing that in an era of highly complex products and unseen 
perverse incentives, disclosure is an insufficient tool, and literacy 
is an elusive goal. 

We would be happy to provide further information. 

Sincerely, 

Center for Responsible Lending: 
National Consumer Law Center: 
US PIRG: 

Contacts: 

Ellen Harnick: 
Center for Responsible Lending: 
Ellen.Harnick@ResponsibleLending.org: 
919-313-8553: 

Kathleen Keest: 
Center For Responsible Lending: 
Kathleen.Keest@ResponsibleLending.org: 
919-313-8548: 

[End of section] 

Appendix XII GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Orice M. Williams, (202) 512-8678 or williamso@gao.gov, or Richard J. 
Hillman, (202) 512-8678 or hillmanr@gao.gov. 

Staff Acknowledgments: 

In addition to the contacts named above, Cody Goebel (Assistant 
Director), Kevin Averyt, Nancy Barry, Rudy Chatlos, Randy Fasnacht, 
Jeanette Franzel, Thomas McCool, Jim McDermott, Kim McGatlin, Thomas 
Melito, Marc Molino, Susan Offutt, Scott Purdy, John Reilly, Barbara 
Roesmann, Paul Thompson, Winnie Tsen, Jim Vitarello, and Steve Westley 
made key contributions to this report. 

[End of section] 

Related GAO Products: 

Troubled Asset Relief Program: Additional Actions Needed to Better 
Ensure Integrity, Accountability, and Transparency. [hyperlink, 
http://www.gao.gov/products/GAO-09-161]. Washington, D.C.: December 2, 
2008. 

Hedge Funds: Regulators and Market Participants Are Taking Steps to 
Strengthen Market Discipline, but Continued Attention Is Needed. 
[hyperlink, http://www.gao.gov/products/GAO-08-200]. Washington, D.C.: 
January 24, 2008. 

Information on Recent Default and Foreclosure Trends for Home Mortgages 
and Associated Economic and Market Developments. [hyperlink, 
http://www.gao.gov/products/GAO-08-78R]. Washington, D.C.: October 16, 
2007. 

Financial Regulation: Industry Trends Continue to Challenge the Federal 
Regulatory Structure. [hyperlink, 
http://www.gao.gov/products/GAO-08-32]. Washington, D.C.: October 12, 
2007. 

Financial Market Regulation: Agencies Engaged in Consolidated 
Supervision Can Strengthen Performance Measurement and Collaboration. 
[hyperlink, http://www.gao.gov/products/GAO-07-154]. Washington, D.C.: 
March 15, 2007. 

Alternative Mortgage Products: Impact on Defaults Remains Unclear, but 
Disclosure of Risks to Borrowers Could Be Improved. [hyperlink, 
http://www.gao.gov/products/GAO-06-1021]. Washington, D.C.: September 
19, 2006. 

Credit Cards: Increased Complexity in Rates and Fees Heightens Need for 
More Effective Disclosures to Consumers. [hyperlink, 
http://www.gao.gov/products/GAO-06-929]. Washington, D.C.: September 
12, 2006. 

Financial Regulation: Industry Changes Prompt Need to Reconsider U.S. 
Regulatory Structure. [hyperlink, 
http://www.gao.gov/products/GAO-05-61]. Washington, D.C.: October 6, 
2004. 

Consumer Protection: Federal and State Agencies Face Challenges in 
Combating Predatory Lending. [hyperlink, 
http://www.gao.gov/products/GAO-04-280]. Washington, D.C.: January 30, 
2004. 

Long-Term Capital Management: Regulators Need to Focus Greater 
Attention on Systemic Risk. [hyperlink, 
http://www.gao.gov/products/GAO/GGD-00-3]. Washington, D.C.: October 
29, 1999. 

Financial Derivatives: Actions Needed to Protect the Financial System. 
[hyperlink, http://www.gao.gov/products/GAO/GGD-94-133]. Washington, 
D.C.: May 18, 1994. 

[End of section] 

Footnotes: 

[1] For more information about these activities, see GAO, Troubled 
Asset Relief Program: Additional Actions Needed to Better Ensure 
Integrity, Accountability, and Transparency, [hyperlink, 
http://www.gao.gov/products/GAO-09-161] (Washington, D.C.: Dec. 2, 
2008). 

[2] Throughout this report, we use the term "financial regulatory 
system" to refer broadly to both the financial regulatory structure-- 
that is, the number and organization of financial regulatory agencies-
-as well as other aspects of financial regulation, including agency 
responsibilities, and mechanisms and authorities available to agencies 
for fulfilling such responsibilities. 

[3] See Department of the Treasury, Blueprint for a Modernized 
Financial Regulatory Structure (Washington, D.C., March 2008); 
Financial Services Roundtable, The Blueprint for U.S. Financial 
Services Competitiveness (Washington, D.C., Nov. 7, 2007); Timothy F. 
Geithner, President and Chief Executive Officer, Federal Reserve Bank 
of New York, "Reducing Systemic Risk in a Dynamic Financial System" 
(speech, New York, June 9, 2008); and Ben S. Bernanke, Chairman, 
Federal Reserve, "Reducing Systemic Risk" (speech, Jackson Hole, Wyo., 
Aug. 22, 2008). 

[4] Pub. L. No. 110-343, § 105(c). 

[5] For example, see GAO, Financial Regulation: Industry Trends 
Continue to Challenge the Federal Regulatory Structure, [hyperlink, 
http://www.gao.gov/products/GAO-08-32] (Washington, D.C.: Oct. 12, 
2007); and Financial Regulation: Industry Changes Prompt Need to 
Reconsider U.S. Regulatory Structure, [hyperlink, 
http://www.gao.gov/products/GAO-05-61] (Washington, D.C.: Oct. 6, 
2004). See Related GAO Products appendix for additional reports. 

[6] Staff at the Federal Reserve Banks act as supervisors in 
conjunction with the Board. 

[7] Thrifts, also known as savings and loans, are financial 
institutions that accept deposits and make loans, particularly for home 
mortgages. Until 1989, thrift deposits were federally insured by the 
Federal Savings and Loan Insurance Corporation (FSLIC), which was 
created by the National Housing Act of 1934. After experiencing 
solvency problems in connection with the savings and loan crisis of the 
1980s, FSLIC was abolished and its insurance function was transferred 
to FDIC. 

[8] The Securities Act of 1933 (1933 Act), 48 Stat. 74. et. seq., 
assigned federal supervision of securities to the Federal Trade 
Commission (FTC) by, among other things, requiring that securities 
offerings subject to the act's registration requirements be registered 
with the FTC. See 1933 Act, §§ 2, 5, 6 (May 27, 1933). In the 1934 act, 
Congress replaced the FTC's role by transferring its powers, duties, 
and functions under the 1933 act to SEC. See Securities Exchange Act of 
1934, 48 Stat. 881, §§ 3(a), 210 (June 6, 1934). 

[9] The National Securities Markets Improvement Act, Pub. L. No. 104- 
290 (Oct. 11, 1996), pre-empted state securities registration 
requirements for all but a subset of small securities products and 
limited state supervision of broker-dealers, but left intact the right 
of states to investigate securities fraud. 

[10] Credit unions are member-owned financial institutions that 
generally offer their members services similar to those provided by 
banks. 

[11] Home Owners' Loan Act of 1933, 48 Stat. 128 (June 13, 1933). The 
administration of the Federal Credit Union Act was originally vested in 
the Farm Credit Administration (Act of June 26, 1934, 48 Stat. 1216.) 
Executive Order No. 9148, dated April 27, 1942 (7 F.R. 3145), 
transferred the functions, powers and duties of the Farm Credit 
Administration to FDIC. Effective July 29, 1948, the powers, duties and 
functions transferred to FDIC were transferred to the Federal Security 
Agency. (Act of June 29, 1948, 62 Stat. 1091.) Reorganization Plan No. 
1 of 1953, effective April 11, 1953, abolished the Federal Security 
Agency and transferred the Bureau of Federal Credit Unions, together 
with other agencies of the Federal Security Agency, to the Department 
of Health, Education, and Welfare. (67 Stat. 631, 18 F.R. 2053.) 

[12] Public Law 91-206 (Mar. 10, 1970, 84 Stat. 49) created the 
National Credit Union Administration as an independent agency and 
transferred all of the functions of the Bureau of Federal Credit Unions 
to the new administration. 

[13] Federally insured state credit unions also are subject to 
supervision by NCUA. 

[14] Pub. L. No. 101-73 § 301 (Aug. 9, 1989). 

[15] The five federal depository institution regulators discussed 
earlier coordinate formally through the Federal Financial Institutions 
Examination Council, an interagency body that was established in 1979 
and is empowered to (1) prescribe uniform principles, standards, and 
report forms for the federal examination of financial institutions; and 
(2) make recommendations to promote uniformity in the supervision of 
financial institutions. 

[16] The Grain Futures Act (ch. 369, 42 Stat. 998, Sept. 21, 1922). In 
1936 the act was renamed the "Commodity Exchange Act (CEA)," which, 
among other things, created the Commodity Exchange Commission (CEC), a 
predecessor agency to the Commodity Futures Trading Commission. 49 
Stat. 1491 (June 15, 1936). 

[17] Commodity Futures Trading Commission Act, Pub. L. No. 93-463 (Oct. 
23, 1974). 

[18] A derivative is a financial instrument representing a right or 
obligation based on the value at a particular time of an underlying 
asset, reference rate, or index, such as a stock, bond, agricultural or 
other physical commodity, interest rate, currency exchange rate, or 
stock index. Derivatives contracts are used by firms around the world 
to manage market risk--the exposure to the possibility of financial 
loss caused by adverse changes in the values of assets or liabilities-
-by transferring it from entities less willing or able to manage it to 
those more willing and able to do so. Common types of derivatives 
include futures, options, forwards, and swaps and can be traded through 
an exchange, known as exchange-traded, or privately, known as over-the 
counter. 

[19] Up until 1944, insurance was not considered interstate commerce 
and, therefore, was not subject to federal regulation. In United States 
v. South-Eastern Underwriters Ass'n, 322 U.S. 533 (1944) the Supreme 
Court held that Congress could regulate insurance transactions that 
truly are interstate. Congress subsequently enacted the McCarran- 
Ferguson Act (Mar. 9, 1945), ch. 20, 59 Stat. 33, which provides that 
state laws apply to insurance unless they are specifically pre-empted 
by Congress. See 15 U.S.C. § 1011. 

[20] NAIC is made up of the heads of the insurance departments of 50 
states, the District of Columbia, and U.S. territories to provide a 
forum for the development of uniform policy when uniformity is 
appropriate. 

[21] Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 
title I, subtitle A (July 30, 2008). 

[22] The 12 Federal Home Loan Banks form a system of regional 
cooperatives, each with its own president and board of directors, 
located in different regions of the country. Their statutory mission is 
to provide cost-effective funding to members for use in housing, 
community, and economic development; to provide regional affordable 
housing programs, which create housing opportunities for low-and 
moderate-income families; to support housing finance through advances 
and mortgage programs; and to serve as a reliable source of liquidity 
for its membership. 

[23] OFHEO was created in title XIII of the Housing and Community 
Development Act (1992), Pub. L. No. 102-550 (Oct. 28, 1992). In 1932, 
the Federal Home Loan Bank Act created the Federal Home Loan Bank 
System to provide liquidity to thrifts to make home mortgages. 
Oversight of these responsibilities was later transferred to the 
Federal Housing Finance Board. 

[24] Gramm-Leach-Bliley Act, Pub. L. No. 106-102 (Nov. 12, 1999). 
Although originally precluded from conducting significant securities 
underwriting activities, bank holding companies were permitted to 
conduct more of such activities over the years. For example, in 1987, 
the Federal Reserve allowed the subsidiaries of bank holding companies 
to engage in securities underwriting activities up to 5 percent of 
their revenue. Over time, the Federal Reserve also expanded the types 
of securities that banks could conduct business in and raised the 
revenue limit to 10 percent in 1989 and to 25 percent in 1996. 

[25] Pub. L. No. 107-204 (July 30, 2002). 

[26] We include discussion of audit and accounting standards in this 
report because any new effort to examine the structure of financial 
regulation in the United States could include consideration of the 
process for creating and adopting these standards. However, determining 
whether the oversight of this process should be changed was not part of 
the scope of this report. 

[27] Gianni De Nicoló, Philip Bartholomew, Jahanara Zaman, and Mary 
Zephirin, "Bank Consolidation, Internationalization, and 
Conglomeration: Trends and Implications for Financial Risk" (IMF 
Working Paper 03/158, Washington, D.C., July 2003). 

[28] Group of Thirty, The Structure of Financial Supervision: 
Approaches and Challenges in a Global Marketplace (Washington, D.C., 
2008). The Group of Thirty, established in 1978, is a private, 
nonprofit, international body--composed of very senior representatives 
of the private and public sectors and academia--that consults and 
publishes papers on international economic and monetary affairs. 

[29] GAO, Financial Market Regulation: Agencies Engaged in Consolidated 
Supervision Can Strengthen Performance Measurement and Collaboration, 
[hyperlink, http://www.gao.gov/products/GAO-07-154] (Washington, D.C.: 
Mar. 15, 2007). 

[30] Under the CSE program, which SEC initiated pursuant to its 
capitalization requirements for broker-dealers, SEC instituted a system 
for supervising large broker-dealers at the holding company level. See 
69 Fed. Reg. 34428 (June 21, 2004). Previously, SEC had focused its 
broker-dealer net capital regulations only upon the firms themselves, 
not their holding companies or other subsidiaries. 

[31] 69 Fed. Reg. 34428 at n. 9. 

[32] SEC Press Release (2008-230), Chairman Cox Announces End of 
Consolidated Supervised Entities Program (Sept. 26, 2008). 

[33] Senate Committee on Banking, Housing, and Urban Affairs, Condition 
of the Banking System, 110th Cong., 2nd sess., June 5, 2008 (testimony 
of Federal Reserve Vice Chairman Donald L. Kohn). 

[34] [hyperlink, http://www.gao.gov/products/GAO-07-154]. 

[35] AIG is subject to OTS supervision as a savings and loan holding 
company because of its control of a thrift. See, e.g., 12 U.S.C. § 
1467a(a)(1)(D), (H). 

[36] The President's Working Group on Financial Markets consists of the 
Secretary of the Treasury, and the Chairmen of the Federal Reserve, 
SEC, and CFTC. 

[37] We have noted limitations on effectively planning strategies that 
cut across regulatory agencies. See [hyperlink, 
http://www.gao.gov/products/GAO-05-61]. 

[38] For the purposes of this report, nonbank lenders are those that 
are not banks, thrifts, or credit unions. Such entities include 
independent mortgage lenders, subsidiaries of national banks, 
subsidiaries of thrifts, and nonbank mortgage lending subsidiaries of 
holding companies. Although we include operating subsidiaries of 
national banks in the category of nonbanks, they are subject to the 
same federal requirements and OCC supervision and examination as their 
parent bank, according to an OCC official. 

[39] Of the 21 nonbank lenders, 7 were subsidiaries of national banks, 
thrifts, or holding companies. 

[40] GAO, Consumer Protection: Federal and State Agencies Face 
Challenges in Combating Predatory Lending, [hyperlink, 
http://www.gao.gov/products/GAO-04-280] (Washington, D.C.: Jan. 30, 
2004); Alternative Mortgage Products: Impact on Defaults Remains 
Unclear, but Disclosure of Risks to Borrowers Could Be Improved, 
[hyperlink, http://www.gao.gov/products/GAO-06-1021] (Washington, D.C.: 
Sept. 19, 2006); and Information on Recent Default and Foreclosure 
Trends for Home Mortgages and Associated Economic and Market 
Developments, [hyperlink, http://www.gao.gov/products/GAO-08-78R] 
(Washington, D.C.: Oct. 16, 2007). 

[41] [hyperlink, http://www.gao.gov/products/GAO-08-78R]. 

[42] "Secure and Fair Enforcement for Mortgage Licensing Act of 2008" 
or "S.A.F.E. Mortgage Licensing Act of 2008", Pub. L. No. 110-289, 
title V. 

[43] Although there is no statutory definition of hedge funds, the term 
is commonly used to describe pooled investment vehicles directed by 
professional managers that often engage in active trading of various 
types of assets such as securities and derivatives. 

[44] See GAO, Hedge Funds: Regulators and Market Participants Are 
Taking Steps to Strengthen Market Discipline, but Continued Attention 
Is Needed, [hyperlink, http://www.gao.gov/products/GAO-08-200] 
(Washington, D.C.: Jan. 24, 2008), 9. 

[45] Under the Securities Act of 1933, a public offering or sale of 
securities must be registered with SEC, unless otherwise exempted. In 
order to exempt an offering or sale of hedge fund shares (ownership 
interests) to investors from registration under the Securities Act of 
1933, most hedge funds restrict their sales to accredited investors in 
compliance with the safe harbor requirements of Rule 506 of Regulation 
D. See 15 U.S.C. § 77d and § 77e; 17 C.F.R. § 230.506 (2007). Such 
investors must meet certain wealth and income thresholds. In addition, 
hedge funds typically limit the number of investors to fewer than 500, 
so as not to fall within the purview of Section 12(g) of the Securities 
Exchange Act of 1934, which requires the registration of any class of 
equity securities (other than exempted securities) held of record by 
500 or more persons. 15 U.S.C. § 78l(g). 

[46] The registration and regulatory requirements applicable to 
Commodity Pool Operators and Commodity Trading Advisors are subject to 
various exceptions and exemptions contained in CFTC regulations. See, 
e.g., 17 C.F.R. Secs. 4.5 (exclusion from definition of CPO for pools 
subject to other types of regulation such as supervision as an insured 
depository institution, registration under the Investment Company Act 
of 1940, or state regulation as an insurance company), 4.7 (exemptions 
from disclosure requirements for CPOs and CTAs offering or selling 
interests to qualified eligible persons or directing or guiding their 
accounts), 4.12(b) (disclosure exemption for CPOs operating pools 
offered and sold pursuant to the 1933 Securities Act or an exemption 
from the Act), 4.13 (exemption from CPO registration), 4.14 (exemption 
from CTA registration). 

[47] 69 Fed. Reg. 72054 (Dec. 10, 2004). 

[48] See Goldstein v. Securities and Exchange Commission, 451 F.3d 873 
(D.C. Cir. 2006). In Goldstein, the petitioner challenged an SEC 
regulation under the Investment Adviser's Act that defined "client" to 
include hedge fund investors and, therefore, prevented hedge fund 
advisers from qualifying for an exemption from registration for 
investment advisers with fewer than 15 clients. See Goldstein, 451 F.3d 
at 874-76. The Court of Appeals vacated the SEC's regulation. While 
hedge fund advisers may be exempt from registration, the anti-fraud 
provisions of the Advisers Act apply to all investment advisers, 
whether or not they are required to register under the Advisers Act. 
See Goldstein, 451 F.3d at 876. In August 2007, SEC adopted a final 
rule under the Investment Advisers Act (rule 206(4)-8 which prohibits 
advisers from (1) making false or misleading statements to investors or 
prospective investors in hedge funds and other pooled investment 
vehicles they advise, or (2) otherwise defrauding these investors. 72 
Fed. Reg. 44756 (Aug. 9, 2007)). 

[49] A counterparty is the opposite party in a bilateral agreement, 
contract, or transaction. 

[50] GAO, Long-Term Capital Management: Regulators Need to Focus 
Greater Attention on Systemic Risk, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-00-3] (Washington, D.C.: Oct. 29, 
1999). 

[51] See [hyperlink, http://www.gao.gov/products/GAO-08-200]. 
Counterparty credit risk is the risk that a loss will be incurred if a 
counterparty to a transaction does not fulfill its financial 
obligations in a timely manner. 

[52] SEC, Summary Report of Issues Identified in the Commission Staff's 
Examinations of Select Credit Rating Agencies (Washington, D.C., July 
8, 2008). 

[53] Previously, SEC regulations referred to credit ratings by 
"nationally recognized statistical rating organizations," or NRSROs, 
but this designation was not established or defined in statute. SEC 
staff identified credit rating agencies as NRSROs through a no-action 
letter process in which they determine whether a rating agency had 
achieved broad market acceptance for its ratings. 

[54] Credit Rating Agency Reform Act of 2006, Pub. L. No. 109-291 
(Sept. 29, 2006). Under the act, a credit rating agency seeking to be 
treated as an NRSRO must apply for, and be granted, registration with 
SEC, make public in its application certain information to help persons 
assess its credibility, and implement procedures to manage the handling 
of material nonpublic information and conflicts of interest. In 
addition, the act provides the SEC with rulemaking authority to 
prescribe: the form of the application (including requiring the 
furnishing of additional information); the records an NRSRO must make 
and retain; the financial reports an NRSRO must furnish to SEC on a 
periodic basis; the specific procedures an NRSRO must implement to 
manage the handling of material nonpublic information; the conflicts of 
interest an NRSRO must manage or avoid altogether; and the practices 
that an NRSRO must not engage in if SEC determines they are unfair, 
coercive, or abusive. The act expressly prohibits SEC from regulating 
the rating agencies' methodologies or the substance of their ratings. 
Pub. L. No. 109-291 § 4(a). SEC adopted rules implementing the act in 
June 2007. 72 Fed. Reg. 33564 (June 18, 2007). 

[55] CDO cash flows also can be affected by other contract terms, such 
as detailed provisions that divert payments from the junior classes to 
the more senior classes when certain conditions are met, such as if the 
portfolio value or interest proceeds fall below a certain level. 

[56] For more information, see The Joint Forum, Bank for International 
Settlements, Credit Risk Transfer: Developments from 2005 to 2007 
(Basel, Switzerland, April 2008). 

[57] See the Senior Supervisors Group, Observations on Risk Management 
Practices during the Recent Market Turbulence (New York, Mar. 6, 2008). 

[58] See the Financial Stability Forum, Report of the Financial 
Stability Forum on Enhancing Market and Institutional Resilience 
(Basel, Switzerland, Apr. 7, 2008). The Financial Stability Forum 
promotes international financial stability through information exchange 
and international cooperation in financial supervision and 
surveillance. It is composed of senior representatives of national 
financial authorities and various international financial organizations 
and the European Central Bank. 

[59] The notional amount is the amount upon which payments between 
parties to certain types of derivatives contracts are based. When this 
amount is not exchanged, it is not a measure of the amount at risk in a 
transaction. According to the Bank for International Settlements, the 
amount at risk, as measured by the gross market value of OTC 
derivatives outstanding, was $15 trillion, as of December 2007, or 
about 2 percent of the notional/contract amount. (The gross market 
value is the cost that would be incurred if the outstanding contracts 
were replaced at prevailing market prices.) 

[60] GAO, Financial Derivatives: Actions Needed to Protect the 
Financial System, [hyperlink, http://www.gao.gov/products/GAO/GGD-94-
133] (Washington, D.C.: May 18, 1994). 

[61] Subsequently, the Federal Reserve agreed to loan AIG up to an 
additional $38 billion. In November 2008, the Federal Reserve and U.S. 
Treasury restructured these lending arrangements with a new financial 
support package totaling over $150 billion. 

[62] See [hyperlink, http://www.gao.gov/products/GAO-06-1021]. 

[63] Federal Trade Commission, Improving Consumer Mortgage Disclosures: 
An Empirical Assessment of Current and Prototype Disclosure Forms: A 
Bureau of Economics Staff Report. (Washington D.C.: June 2007). 

[64] House of Representatives Committee on Financial Services, 
Subcommittee on Financial Institutions and Consumer Credit, Subprime 
Mortgages, 110TH Cong. 2ND sess., Mar. 27, 2007 (testimony of Sandra F. 
Braunstein, Director, Division of Consumer and Community Affairs, 
Federal Reserve). 

[65] 71 Fed. Reg. 58609 (Oct. 4, 2006) "Interagency Guidance on 
Nontraditional Mortgage Product Risks"; 72 Fed. Reg. 37569 (Jul. 10, 
2007) "Statement on Subprime Mortgage Lending". 

[66] See GAO, Credit Cards: Increased Complexity in Rates and Fees 
Heightens Need for More Effective Disclosures to Consumers, [hyperlink, 
http://www.gao.gov/products/GAO-06-929] (Washington, D.C.: Sept. 12, 
2006). 

[67] See [hyperlink, http://www.gao.gov/products/GAO-04-280]. 

[68] See GAO, Financial Literacy and Education Commission: Further 
Progress Needed to Ensure an Effective National Strategy, [hyperlink, 
http://www.gao.gov/products/GAO-07-100] (Washington, D.C.: Dec. 4, 
2006). 

[69] FASB issues generally accepted accounting principles for financial 
statements prepared by nongovernmental entities in the United States. 
SEC issues financial reporting and disclosure requirements for U.S. 
publicly traded companies and recognizes the standards issued by FASB 
as "generally accepted" within the United States. SEC oversees FASB's 
standard-setting activities. 

[70] FASB Staff Position No. FAS 157-3, Determining the Fair Value of a 
Financial Asset When the Market for That Asset Is Not Active (Oct. 10, 
2008); and SEC Press Release No. 2008-234, SEC Office of the Chief 
Accountant and FASB Staff Clarifications on Fair Value Accounting 
(Sept. 30, 2008). 

[71] On September 15, 2008, FASB issued an exposure draft, Disclosures 
about Transfers of Financial Assets and Interests in Variable Interest 
Entities, for a 30-day comment period that closed on October 15, 2008. 
On December 11, 2008, FASB issued FASB Staff Position (FSP) FAS 140-4 
and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about 
Transfers of Financial Assets and Interests in Variable Interest 
Entities. This document requires additional disclosures about transfers 
of financial assets and variable interests in qualifying special 
purpose entities. It also requires public enterprises to provide 
additional disclosures about their involvement with variable interest 
entities. 

[72] [hyperlink, http://www.gao.gov/products/GAO-05-61]. 

[73] Letter from Representative Michael Oxley et al. to Chairman Alan 
Greenspan et al., Nov. 3, 2003. 

[74] [hyperlink, http://www.gao.gov/products/GAO-07-154]. 

[75] See GAO, Homeland Security: Critical Design and Implementation 
Issues, [hyperlink, http://www.gao.gov/products/GAO-02-957T]. 
(Washington, D.C.: July 17, 2002). 

[76] GAO, Financial Regulation: Industry Changes Prompt Need to 
Reconsider U.S. Regulatory Structure, [hyperlink, 
http://www.gao.gov/products/GAO-05-61] (Washington, D.C.: Oct. 6, 
2004); and Financial Regulation: Industry Trends Continue to Challenge 
the Federal Regulatory Structure, [hyperlink, 
http://www.gao.gov/products/GAO-08-32] (Washington, D.C.: Oct. 12, 
2007). 

[77] The American Bankers Association brings together banks of all 
sizes and charters into one association. ABA works to enhance the 
competitiveness of the nation's banking industry and strengthen 
America's economy and communities. Its members - the majority of which 
are banks with less than $125 million in assets - represent over 95 
percent of the industry's $13.6 trillion in assets and employ over 2 
million men and women. 

[78] Further, the threat of federal preemption and its absence of 
suitable consumer protection gave the nonbank lenders the argument that 
they just wanted a “level playing field,” –on a field largely without 
rules. To that extent, the regulatory structure played into the 
separate thread of whether there were adequate tools for regulators. 
The preemption agenda was part of the momentum to the lowest common 
denominator for the substance of regulation. 

[79] Recent studies have found that the securitization process in fact 
contributed to the aggressive lending and poor underwriting. See, e.g. 
Benjamin J. Keys, Tanmoy Mikherjee, Amit Seru, Vikrant Vig, 
Securitization and Screening: Evidence From Subprime Mortgage Backed 
Securities, pp. 26-27 (January 2008), available at [hyperlink, 
http://www2.law.columbia.edu/contracteconomics/conferences/laweconomicsS
08/Vig%20paper.pdf]. 

[80] For more detail on causes of the crisis, see Testimony of Eric 
Stein, Center for Responsible Lending, Before the U.S. Senate Committee 
on Banking, Housing and Urban Affairs (October 16, 2008), [hyperlink: 
http://banking.senate.gov/public/_files/RevisedSenateTestimony101608Hear
ingSteinFinalFinal.pdf]. 

[81] Rick Brooks and Ruth Simon, Subprime Debacle Traps Even Very 
Credit-Worthy As Housing Boomed, Industry Pushed Loans To a Broader 
Market, Wall Street Journal at A1 (Dec. 3, 2007). 

[82] Letter from Coalition for Fair & Affordable Lending to Ben S. 
Bernanke, Sheila C. Bair, John C. Dugan, John M. Reich, JoAnn Johnson, 
and Neil Milner (Jan. 25, 2007) at 3. 

[83] See, e.g. Subprime Lending: A Net Drain on Homeownership, CRL 
Issue Paper, No. 14 (March 27, 2007). 

[84] See, e.g. Lei Ding, Roberto G. Quercia, Wei Li, and Janneke 
Ratcliffe, Risky Borrowers or Risky Mortgages: Disaggregating Effects 
Using Propensity Score Models, Center for Community Capital, Univ. of 
North Carolina & Center for Responsible Lending (Working Paper, Sept. 
13, 2008). 

[85] Countrywide, 3Q07 Earnings Supplemental Presentation (October 26, 
2007). To again emphasize that the federal banking regulators 
contributed to the problem, some $161 billion of those payment option 
ARMs were issued when Countrywide was under the OCC’s watch. 

[86] After filing for bankruptcy, the CEO of one mortgage lender 
explained it this way to the New York Times, “The market is paying me 
to do a no-income-verification loan more than it is paying me to do the 
full documentation loans,” he said. “What would you do?” Vikas Bajaj 
and Christine Haughney, Tremors at the Door: More People with Weak 
Credit Are Defaulting on Mortgages, New York Times (January 26, 2007). 

[End of section] 

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