TBA Law Blog

Posted by: Kathryn Edge on Sep 24, 2009

Journal Issue Date: Oct 2009

Journal Name: October 2009 - Vol. 45, No. 10


The Obama Administration has proposed radical changes in the ways banks and other financial companies are regulated. While at this writing, none of these proposals has been implemented, it is instructive to examine the outline of the Department of Treasury's "new foundation."

The plan proposes to meet these five key objectives:

  • Promote robust supervision and regulation of financial firms;
  • Establish comprehensive supervision of financial markets;
  • Protect consumers and investors from financial abuse;
  • Provide the government with the tools it needs to manage financial crises; and
  • Raise international regulatory standards and improve international cooperation.

Robust Supervision and Regulation

Because financial institutions are critical to market functioning, no one disagrees that they should be highly regulated. Most bankers and their lawyers believe that depository institutions are already among the most highly regulated companies in the United States' economy. The early "bank" failures that precipitated the unprecedented financial meltdown were not depository, commercial banks but investment banks — a distinction that was lost on popular media. Nevertheless, the Administration proposes the following changes to accountability in financial oversight and supervision:

  • A new Financial Services Oversight Council of financial regulators that will identify emerging systemic risks and improve interagency cooperation. Some of us thought that the Federal Financial Institutions Examination Council (FFIEC) already served as a regulatory think tank for this purpose. The FFIEC is a formal, interagency body that is charged with prescribing uniform principles, standards, and report forms for the federal examination of financial institutions. Its members include representatives of the Board of Governors of the Federal Reserve System; the Federal Deposit Insurance Corporation; the National Credit Union Administration; the Office of the Comptroller of the Currency; and the Office of Thrift Supervision. In addition, there is a State Liaison Committee member to represent the interests of state regulators.

The new Council would be chaired by Treasury and would have as its members the heads of the primary federal financial regulators (including some new players and omitting the Office of Thrift Supervision). The Council would have the power to gather information from any financial firm and to refer its concerns for emerging risks to the attention of the regulators who have the authority to respond.

  • New authority for the Federal Reserve to supervise all firms that could pose a threat to financial stability, even those that do not own banks. The proposal would expand the Federal Reserve's authority from being the regulator of firms that own banks to authority over all large, interconnected firms whose failure could threaten the stability of the system. These companies would face stricter regulation than other regulated firms, including higher capital requirements and consolidated regulation.
  • Stronger capital and other prudential standards for all financial firms, and even higher standards for large, interconnected firms. Under the Administration's plan, Treasury will lead a working group to reevaluate by Dec. 31, 2009, the capital requirements for all banks, bank holding companies, and financial holding companies. In addition, Treasury is charged with leading a working group to conduct a fundamental reassessment of the supervision of banks and bank holding companies, the deadline for which is Oct. 1, 2009.
  • A new National Bank Supervisor to supervise all federally chartered banks and the elimination of the federal thrift charter. Since 1864, the Office of the Comptroller of the Currency has supervised and regulated national banks. The proposal would add federally chartered savings associations and savings banks to the agency's responsibility and change the name to "National Bank Supervisor." Federal thrifts would convert to national banks, but the one advantage available to a federal thrift (the right to branch across state lines without regard to state law restrictions) would be extended to both state and national banks - opening up the country to true "interstate" branching, subject to safety and soundness concerns.
  • The registration of advisers of hedge funds and other private pools of capital with the SEC under the Investment Advisers Act. Advisers would be required to report information on the funds they manage sufficient to assess whether any fund poses a threat to financial stability.

Comprehensive Supervision of Financial Markets

The Administration's plan stresses that our financial markets must be strong enough to withstand both systemic stress and the failure of one or more large institutions. The proposals include:

  • Enhanced regulation of securitization markets. This increased regulation would include new requirements for market transparency, stronger regulation of credit rating agencies, and a requirement that issuers and originators retain a financial interest in securitized loans. Among the specific recommendations is a requirement to align compensation of market participants with long-term performance of the underlying loans.
  • Comprehensive regulation of all over-the-counter derivatives. Treasury recommends that all OTC derivatives markets be subject to comprehensive regulations that address public policy objectives, including (i) preventing activities in those markets from posing risks to the financial system; (ii) promoting the efficiency and transparency of those markets; (iii) preventing market manipulation and fraud; and (iv) ensuring that OTC derivatives are not marketed to unsophisticated parties.
  • New authority for the Federal Reserve to oversee payment, clearing and settlement systems. Presumably, access to the Fed would be expanded to all financial firms, not just banks.

Protect Consumers and Investors from Financial Abuse

One of the key objectives of the Administration's "new foundation" plan is to restore trust in financial markets, particularly consumer confidence. The proposals include:

  • A new Consumer Financial Protection Agency. This is one of the most controversial of the proposals from the bankers' perspective. Banks, thrifts, and credit unions are already highly regulated by their current regulators with respect to consumer protection laws and regulations. The new proposal would shift the responsibility for this regulation to yet another agency charged with protecting consumers from unfair, deceptive and abusive practices. The plan would be to create a single, primary federal consumer protection supervisor that would regulate providers of financial products and services, regardless of the provider of those services. The CFPA's rules would be a floor and not a ceiling, so if a state had stricter consumer protection laws, the state could enforce those laws even if the institution is federally chartered. This is a dramatic shift in states' rights under the proposal. The CFPA would coordinate enforcement efforts with the states.

Provide the Government with the Tools It Needs to Manage Financial Crises

The Administration seeks the tools it needs to manage a future financial crisis that fall somewhere between the bailouts that our grandchildren will be paying for and complete financial collapse. The proposal includes:

  • A new regime to resolve nonbank financial institutions whose failure could have serious systemic effects. The new rules would be modeled after the existing resolution protocols for insured, depository institutions under the Federal Deposit Insurance Act. The government's responses to the impending bankruptcies of Bear Stearns, Lehman Brothers, and AIG were hampered by the lack of statutory framework for avoiding the disorderly failure of these nonbank firms. Because there was no other alternative, the government used the Federal Reserve's lending authority to "resolve" Bear Stearns and AIG but did not use that vehicle to prevent the bankruptcy of Lehman Brothers. What is yet unclear from the Treasury's plan is precisely how new laws or regulations will lessen the impact if one of these big investment banks were to fail in a way that is different from the federal rescue that was created on the fly. If the other parts of the "new foundation" plan work, perhaps we will never have to find out.

Raise International Regulatory Standards

In our global economy, it is not enough for America to fix its systemic financial problems. The Treasury's proposal would seek to strengthen the capital framework for international firms; improve oversight of global financial markets; coordinate supervision of internationally active firms; and enhance crisis management tools. Toward these ambitious ends, in April 2009 at the London Summit, the G-20 Leaders issued a declaration outlining comprehensive plans for financial regulatory reform. Treasury asserts that the domestic regulatory reform initiatives outlined in its plan are consistent with these international commitments.

In addition to these objectives, the Treasury plan also describes the creation of an Office of National Insurance with the Treasury Department to promote national coordination in the insurance sector. Insurance has historically been regulated solely by the states, so this debate will be fraught with those historic biases, but query why banking should be regulated on a national basis while insurance regulation remains local. The plan, among other principles related to federal regulation of insurance, calls for "increased national uniformity through either a federal charter or effective action by the states. — The plan calls state regulation "highly fragmented, inconsistent, and inefficient" — and in the words of some of our southern forbearers, "Them's fightin' words!"

The Treasury's plan spans 88 pages, chocked full of financial acronyms and ideas that will gore lots of oxen. This article highlights only some of the principal initiatives and omits, for example, a discussion of government-sponsored entities (GSEs); how the SEC needs expanded authority to promote transparency in investor disclosures; and the recommendation that accounting standard setters make consistent the application of fair value accounting standards. The Administration barbecues a lot of sacred cows in the Treasury's plan. We'll eventually see who leaves the picnic hungry.

Kathryn Reed Edge KATHRYN REED EDGE is a member of Miller & Martin PLLC, a regional law firm with offices in Nashville, Chattanooga, and Atlanta. She heads the firm’s Commercial Department and concentrates her practice in representing financial institutions. She is a past president of the Tennessee Bar Association and is a member of the editorial board for the Tennessee Bar Journal.