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Banking New York - Superintendent's Column - The Connection Between the Dual Banking System and Balanced Regulation


December 1, 2007

As I’m writing this, New York City has just had its first snowfall of the season, reminding me that my first year as Superintendent is almost at an end. As someone who joined state government for the first time after 25 years in the private sector, I was forewarned by previous Superintendents that there is a tradition of financial emergencies striking at the beginning of a term. The start of my own term was no different. As soon as I showed up at the office, I was faced head on with two major challenges that were significantly intertwined- the subprime mortgage crisis and pre-emption. While the problems in the mortgage market take first place, the two issues came together for me in analyzing the role of the states in developing solutions.

We recognize the role that nontraditional lending institutions, many of which are based outside of New York, play in subprime lending. Nevertheless, we also have to acknowledge that the entire industry has been involved in the process to a certain extent, whether as wholesale lender, servicer, securitizer, or investor. And, regardless of where the loans were originated, the problems have broad repercussions, in terms of industry reputation and confidence in the mortgage market. When confronted with the subprime problem and the foreclosure crisis, the state’s ability to design an effective response was further complicated by the preemption issue.

From my perspective, the upside to the preemption debate is that it provides a unique opportunity to reassess the balance of power between the state and federal government, particularly as it relates to consumer protection. From your perspective as industry leaders, while I am sure you share my concerns around consumer protection and market stability, my concern over preemption might not evoke a similar sympathy.

After all, the Supreme Court’s decision in Watters v. Wachovia, which upheld federal preemption of state consumer protection laws for operating subsidiaries of national banks, has been described by some as a victory for industry. While the decision certainly is a loss for state regulators, this loss does not automatically translate into an industry gain. The Watters decision jeopardizes the careful checks and balances in the dual banking system, and industry should be keen to see the system’s built-in restraints on excessive regulation maintained.

The connection between the dual banking system and balanced regulation may not always be readily apparent. Instead, multiple levels of government can seem like an albatross to industry, especially during times when one level of government is prepared to grant greater latitude than the other. However, it is precisely this type of competitive tension among regulators that the dual banking system was designed to create. The purpose is not to frustrate industry, but to help ensure that the regulations and public policies that emerge from this dialectic process are both necessary and optimal.

While we want to remain competitive with respect to foreign markets that may have more consolidated regulatory regimes, and there are opportunities to streamline our system, the basic concept of the dual banking system is still valid. Our federal approach offers many benefits that we ought to preserve, even as we consider how best to equip state government to respond to contemporary challenges in the industry.

Keeping the best of our current system, while adapting to the evolving needs of the 21st century, is one of the goals of Governor Spitzer’s Commission to Modernize the Regulation of Financial Services, on which I serve as a member. We anticipate issuing recommendations over the course of 2008, and I hope to hear your thoughts on maximizing our supervision of banking, insurance, and securities. I expect that the current turmoil in the mortgage market will provide us not only with examples of areas for improvement, but also with models that work to further coordinate regulation.

One of the many lessons the subprime crisis has taught us is that residential mortgage loans are an engine of the economy, a critical sector that deserves multiple levels of oversight. The crisis has also illustrated that protection of mortgage borrowers is not a separate social policy concern, but is inextricably linked with fiscal soundness. We are experiencing this implosion in the mortgage market precisely because the connection between consumer protection and safety and soundness was underappreciated. And as the origination of subprime and nontraditional mortgage loans increased, frankly the federal government has not been as swift to act in predatory lending prevention.

Instead, state governments were the first to respond to this need and translate a heightened concern over the proliferation of subprime mortgage loans into action. When it comes to mortgage loans, the market may be global but the collateral is unavoidably local. This locality means that state government is close to the effect on the community, from displacement of families to related social upheaval.

Being this close to the problem, it is no surprise that states were the early leaders in offering solutions. Perhaps this is also an example of a new form of federalism, in which decentralization at the national level has highlighted the states’ traditional role as overseers of the real estate market in their jurisdictions. New York has not shirked this historic responsibility. Our state’s anti-predatory lending law was among the first in the nation, and state bank supervisors and attorneys general took the lead in landmark consumer settlements for unfair lending practices.

It is not only consumers who benefit from state involvement in the mortgage market. Industry also benefits from having a variety of legal, social, and economic environments in which to innovate and test new business strategies. It’s been said that the states function as “laboratories of democracy,” by providing venues in which new ideas can be proven and then offered to the country as models. While I think that expression is true, the positive role that the states play is much more than an experiment. State supervision and the dual banking system is a time-tested model of oversight that promises the best mix of security and creativity when it functions as intended. 

And so my New Year’s wish is to see the promise of the dual banking system more fully realized, through a deeper level of federal-state cooperation in supervising the mortgage market in 2008.