Richard H. Neiman Superintendent of Banks for the State of New York before the 19th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies Levy Economics Institute of Bard College
April 14, 2010
I am very pleased to be here this evening. I would like to thank the Levy Economics Institute for hosting this premier event for financial policymakers. It has been my pleasure to honor and share dinner with the Minsky family this evening during this 19th Annual Hyman P. Minsky Conference.
I am particularly pleased to follow the lively panel on financial regulation that included Governor Eliot Spitzer since he appointed me as New York’s Superintendent of Banks in March 2007.
That was a little over three years ago. A lot has happened since then, much of which serves as the backdrop to this important conference with its focus on planning a new financial structure.
I hope to add value to the conversation by sharing my perspective through the two hats I wear.The first is as New York’s Superintendent of Banks, our country’s oldest bank regulator (1851). A little background on the Banking Department: The agency has a wide scope of authority with oversight over some 100 state banks which include community and regional banks, large banks like Bank of New York Mellon, our oldest bank Brown Brothers Harriman, as well as our newest Goldman Sachs Bank. We also supervise hundreds of mortgage bankers and brokers; licensed lenders; check cashers; money transmitters and other involved in consumer finance. We also license the vast majority of foreign banking organizations that are active in the U.S. representing over 80% of the foreign bank assets in this country.
My second hat is as one of five members of the TARP Congressional Oversight Panel having been appointed by Speaker Pelosi in Nov. 2008. The Panel, Chaired by Elizabeth Warren, issued it most recent monthly report today focused on Treasury’s foreclosure mitigation efforts.
My views on the financial crisis and the intersection with regulatory reform are largely shaped by the three critical challenges I faced when becoming Superintendent in March of 2007:
- Increasing foreclosures in subprime and the evidence of significant predatory lending;
- Pending legal challenges to state authority in financial services supervision through the Watters v. Wachovia and Cuomo v. Clearinghouse Supreme Court cases. I should note that when I became Superintendent, the case was called Clearinghouse v. Spitzer, as the litigation was initiated as a result of Governor Spitzer’s action as Attorney General.
- Issues around controlling systemic risk, especially with respect to large and complex banking organizations that are active in global markets.
These challenges translate into an urgent mandate for meaningful regulatory reforms, namely protecting consumer and homeowners; modernizing our regulatory architecture within our Federalist banking system; and addressing systemic risk.1. Consumer protection
The first mandate is to strengthen consumer protection. This is a fundamental element that we must get right. Examples of innovative approaches to consumer protection exist across the country. An important part of the story of the mortgage crisis is that diverse states like New York and North Carolina sounded the alarm on subprime lending and predatory practices with legislation and landmark settlements. Unfortunately, the OCC and the OTS did not join the states in this push against predatory lending, but actually thwarted state efforts through aggressive assertion of federal preemption starting in 2004. Even worse, sufficient federal standards were not developed to replace the preempted state laws.
The current proposal to create a new independent consumer protection agency has received much attention – particularly as to where such an agency would be housed. In my view, other important issues may be lost in this debate, such as product suitability, examination and enforcement, and preemption.
Suitability: Much discussion has centered on the authority that a new consumer agency would have with respect to product terms. Deceptive terms should be banned, but some potentially riskier features – like interest-only loans – can be right for certain borrowers. In fact, over-focusing on terms alone can harm consumers by perversely incentivizing banks to pursue loopholes to evade regulation.
So, what really matters is that the product is right for the individual borrower – suitability. Focusing on suitability can impose an even higher compliance duty on the industry – a duty of care for the consumer, to match the right person with the right product and ensure the borrower has the ability to pay. Ultimately, this turns on the quality of loan underwriting. And here there is a key link with safety and soundness. I strongly believe that federal rules to protect consumers are critical but any rulemaking that relates to underwriting standards must be done in a partnership with prudential regulators in order to achieve our collective goal of financial stability.
Examination and Enforcement: The original Obama plan would have shifted consumer compliance exam authority from existing supervisory regulators and consolidated it within a new consumer agency. The Dodd and passed House bills, however, reflect the link to safety and soundness and would leave primary consumer oversight with prudential regulators for institutions under $10 billion. The examination and enforcement powers of a new consumer agency should, in my opinion, function as a back-up to prudential regulators where the primary supervisor fails to act or take appropriate action. The state system provides an example of how back-up authority can work, through the registration of mortgage loan originators under the SAFE Act. The SAFE Act leaves primary responsibility with the states, and provides for federal back-up in the event that states do not have a conforming program.
Preemption: We need national minimum standards to protect consumers. But rules made by a new consumer agency should be a floor not a ceiling, thus allowing states to protect consumers beyond the federal floor. The good news is that the Dodd and passed House bills remove the OCC’s unfettered discretion to overrule state consumer protection laws for national banks. It would restore balance by reiterating that a genuine conflict must exist between state and federal law before preemption can occur. However, the OCC may attempt to create space within terms like “materially impairs” that were added to the legislative language. Experts on both sides of the issue will now debate how much “burden” a state law can impose before it is found to be in conflict. It is also critical that the standard for judicial review of OCC rulings would change. The OCC has been granted enormous deference by the courts, but under the new bill the courts would now need to be persuaded of the OCC’s reasoning. We need to remain vigilant that these improvements for consumers are not bargained away during the legislative process.
2. Regulatory architecture and dual banking
The second mandate is to modernize our regulatory architecture, while preserving the benefits of the dual banking system. Our dual banking system of state-federal oversight may seem cumbersome when compared to more centralized approaches, and there is room for improvement. But there is no one perfect system; when you look around the world with various models, no country was spared the financial crisis.
My overriding concern is to preserve and strengthen our federalist approach to financial oversight, with a greater level of cooperation and collaboration between federal and state regulators. This partnership between states and federal regulators in supervising banks is good for consumers and good for local economies. The original Obama plan recognized this balance and therefore retained the supervisory role for the Federal Reserve and the FDIC, the two agencies that share oversight of state banks with state supervisors.
Monolithic Federal Regulator: However, some have called for the creation of a single, monolithic federal regulator. This idea may have appeal on the surface, but there are pitfalls and serious disadvantages to total consolidation. Most notably, a monolith would increase the risk of regulatory capture by the largest banks, and we would lose the benefits of diverse regulatory viewpoints that have improved our system.
A timely example of the benefits of diversity is the FDIC’s insistence on retaining the leverage ratio in the U.S. implementation of Basel II, when other federal supervisors favored dropping the requirement. The FDIC’s judgment on the leverage ratio was proven right by the crisis. The subtle genius of the dual banking system, with its decentralized approach to decision-making, was also proven right. These are complex financial issues and we need to weigh multiple opinions, just as the Olympics use multiple judges to arrive at a fair outcome.
Dodd bill: The new Dodd bill provides an alternative to the monolith concept and intends to be a strong endorsement of the dual banking system. The Dodd bill, as well as the original Obama plan and the passed House bill, do call for merging the OTS and OCC. I support this approach to consolidation which will end the harmful arbitrage between federal agencies that we know all too well. The Dodd bill also retains what is best in our dual banking system in several respects.
The Dodd bill keeps oversight of foreign banking organizations with the Federal Reserve, which is right decision for many reasons. This leverages the Fed’s extensive expertise in capital markets, which also informs monetary policy, and gives the Fed an important window into systemic risks worldwide.
Importantly, as an alternative to a monolithic regulator, the FDIC would remain a federal counterpart for state banks. But I do have serious concerns over the Fed’s loss of supervision of state-member banks leaving it only with oversight of bank holding companies over $50 billion. This change would create competitive disadvantages that could undermine our federalist approach to supervision from several perspectives.
Large state-member banks would be triple regulated – with the Fed regulating the holding company and the FDIC and State regulating the bank. Thus these banks would be incentivized to replace this triple oversight with dual oversight by the OCC and the Fed by converting to national charters. Further incentivizing such conversions, the largest and most complex institutions may question whether the FDIC’s extensive experience with smaller and mid-size institutions is appropriate for them. And federal preemption also provides an ongoing inducement to change charter which is exactly the type of race to the bottom arbitrage we must stop.
3. Systemic risk
The final mandate is addressing systemic risk. Systemic risk is a heading that encompasses many initiatives that we are hearing about over the course of this conference, such as addressing too-big-to-fail, designing the appropriate resolution authority, identifying the systemic risk regulator, and dealing with derivatives. But even beyond these complex issues, we need to consider the broader question of what we want our banks to be, both as risk-takers and as providers of a social utility. This analysis requires a forward looking framework focused on avoiding future crises, not based on what has happened but on the serious risks of what could happen.
This is the context in which I view the Volcker Rule and the often little noticed Office of Financial Research in the Dodd bill.
Volcker Rule: The Volcker Rule restricting proprietary trading, hedge fund, and private equity activities is important. It is true as the critics contend that these activities did not cause the current crisis. But the proposal is strongly forward-thinking because it addresses the core residual issue from the crisis. That issue is the scope of the federal safety net through explicit and implicit guarantees. Excessive risk-taking through activity unrelated to client business is incompatible with taxpayer guarantees.
Some contend that existing firewalls are sufficient to protect insured deposits from high-risk proprietary trading activity conducted in the holding company and affiliates. But this overlooks the symbiotic relationship among parents, subsidiaries and affiliates. The market's perception does not distinguish between the parent holding company and the bank. As a result, negative events within the holding company can create a lack of confidence in the depository subsidiary. Likewise, the benefits of explicit and implicit guarantees, as well as funding advantages afforded to the bank, can enrich the bank holding company. These benefits may even subsidize the proprietary activities of nonbank affiliates.
The Volcker rule also reduces the likelihood of failure by curtailing speculative activities, and prevents the growth of institutions to the extent they are being driven by those activities. The key challenge will be to draw the right line, while doing no harm by continuing to allow for banks’ appropriate role in market-making.
War gaming: Before concluding, I would like to highlight another aspect of regulatory reform that is not sufficiently addressed in current proposals – that is the need to focus solely on long-term concerns, to address problems before it is too late.
Just as the military pays attention to emerging risks worldwide and plots preemptive scenarios, so must the financial system. In this vein, we need a financial war gaming center to build on the proposed Office of Financial Research, an office which seeks to consolidate financial data into a centralized location within Treasury.
An independent approach to utilizing this information while maintaining a focus on long-term risks is key. The financial war gaming center should provide regular reports to financial policy makers and regulators, but should be made up of thought leaders from the private sector, think tanks, and academia.
The center would have a threefold mission:
- Advanced risk detection for a continuous horizontal look at the financial system, paying special attention to risk of high-impact events, including those with low-probability. Other hot spots are rapidly rising asset prices, very high leverage, fiscal and monetary imbalances, financial infrastructure failures, and over-dependence on models.
- Identify risks of regulatory failure, including gaps in oversight among US agencies and globally, as well as regulatory capture. The right perspective here requires the appropriate distance that an independent view provides.
- Strategic solutions. The center would lay out options to counter emerging risks based on independent and forward-looking analysis. Ideally, industry would self-correct based on this early warning and eliminate the need for government intervention.
The goal with this forward-looking review is not to make fully accurate predictions about future events, but to think creatively about the range of developing risks and take preventive steps.
A year and a half after the financial crisis reached its lowest point, the three urgent mandates for meaningful reform that I have highlighted – the same challenges that I, and many of us in this room, faced early in our current job positions – are still with us today.
All of us certainly hope that the Senate’s consideration of the Dodd bill will be the final step. If we focus on core mandates – to better protect consumers and homeowners, to strengthen the state-federal supervisory partnership, and to control systemic risk – the outcome can be transformational.