The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
5/13/2020 Assistant Secretary Michael S. Barr Remarks to the National Economists Club U.S. DEPARTMENT OF THE TREASURY Press Center Assistant Secretary Michael S. Barr Remarks to the National Economists Club 10/1/2009 TG-306 Washington, DC As Prepared for Delivery Thank you, Ed, for that kind introduction. Good afternoon, everyone, and thanks for the opportunity to be with you today. This is, I think, a particularly important time for you to be gathering – and a particularly opportune moment for me to talk with you about the reforms that the Administration has proposed to strengthen our financial system. As we enter October we pass a year since the most devastating month in modern financial history. The conservatorship of Fannie Mae and Freddie Mac, the largest U.S. bank failure ever when Washington Mutual was closed by the FDIC – and of course, it was just over a year ago that Lehman Brothers filed for bankruptcy. In the panic that followed, our financial system nearly ground to a halt. A swift response prevented a truly catastrophic collapse. But last September's events revealed deep weaknesses in our financial system. It did not take long for the financial contagion to infect the real economy. When President Obama took office, America's growth rate had hit negative 6.3 percent, and monthly job losses had reached 750,000 - the worst in decades. There are indications that we have moved back from the financial brink and are headed toward economic recovery. Important parts of the financial system are back to functioning on their own. Some of the damage to people's savings has been repaired. We have taken the first steps towards reducing the government's direct involvement in the system and reducing the risks that taxpayers are bearing. But we cannot ignore the urgent need for action: our regulatory system is outdated and ineffective, and the weaknesses that contributed to the financial crisis persist. The progress of recovery must not distract us from the project of reform. The Administration has put forward the most sweeping reform of financial regulation since the New Deal, and we are working closely with Congress to enact legislation by the end of this year. Our goals are simple: to give responsible consumers and investors the basic protections they deserve; to lay the foundation for a safer, more stable financial system, less prone to panic and crisis; and to safeguard American taxpayers from bearing risks that ought to be borne by shareholders and creditors. Today, I'd like to focus primarily on one of the key challenges that is at the center of the debate over regulatory reform: how to address the challenge of firms whose failure, absent reform, could threaten the stability of the financial system. Large, highly leveraged, and substantially interconnected financial firms have come to occupy a much larger portion of the U.S. and global financial landscape over the past few decades. The trend toward concentration has not only affected U.S. financial firms. In fact, the financial sectors of most other industrial countries are substantially more concentrated than the U.S. financial sector. The trend can be attributed to several sources. Important sources include a long period of stable economic growth and rapid growth in the size of the overall financial system, increasing opportunities for cross-border financial activity, declining barriers to affiliation between banking firms and other financial firms, improvements in information technology, increased willingness by equity investors to finance complex financial companies, and the rapid growth of derivatives and securities financing markets. Investors and other market participants also favored these firms because of assumptions that their greater diversification would be accompanied by reduced volatility. The growth of the major financial firms over the past few decades – including Fannie Mae, Freddie Mac, and the major investment banks – also likely stemmed in part from the assumption by investors and counterparties that these firms would receive government assistance if they became troubled. This assumption undermined market discipline and contributed, along with weaknesses in our regulatory system, to their growth and excessive risk taking. And the actions taken by the federal government over the past 18 months to support our major financial firms, https://www.treasury.gov/press-center/press-releases/Pages/tg306.aspx 1/4 5/13/2020 Assistant Secretary Michael S. Barr Remarks to the National Economists Club although necessary to prevent the implosion of our financial system and ruinous damage to our economy, have solidified this market perception. Going forward, our strategy is to impose supervisory and capital charges that offset the benefits of perceived government subsidies. We must substantially reduce the moral hazard created by the perception that these subsidies exist; address their corrosive effects on market discipline; and minimize their encouragement of excessive risk-taking. It is important to note at the outset, as I will explain in more detail in a moment, that our plan does not provide a government guarantee for troubled financial firms; it does not create a fixed list of systemically important financial firms; it does not provide incentives for our major financial firms to get bigger, more leveraged, and more interconnected; and it does not give comfort to investors, creditors, counterparties, or management that the government will be there to absorb losses from risky business strategies. Quite the opposite. Some argue that we could better restore market discipline and reduce moral hazard by simply committing that the government will never again bailout a financial firm. We disagree. Such a promise does not bind future governments and ultimately is not credible. Instead, our approach must be real reform that creates bigger buffers in the system, gives the government the necessary tools to better regulate firms and markets, and to better respond to emerging crises. We refuse to leave the country to face the next severe economic stress event with nothing but the same set of inadequate crisis management tools we had to face this crisis. Our plan to protect the financial system and taxpayers from the failure of a major financial firm is comprehensive and robust. The plan is designed principally to promote market discipline and reduce moral hazard by making our financial system safe for the failure of individual firms even very large ones. The plan also is designed to provide disincentives for firms to become too big, complex, leveraged, and interconnected. The plan does this by strengthening the regulation of our major financial firms, improving the resiliency of the broader financial system, and better enabling the government to unwind failing financial firms in an orderly fashion. Our plan has four key components: 1. The federal government must have strong supervisory and regulatory authority over all major financial firms; 2. The supervisory and regulatory standards applicable to our major financial firms must be stricter and more focused on the risks the firms pose to financial stability; 3. Buffers throughout the financial system, including in particular in the financial market infrastructure, must be strengthened; and 4. The federal government must have appropriate tools to resolve failing non-bank financial firms in an orderly fashion to minimize risks to the economy and taxpayers. First, the biggest, most interconnected financial firms must be subject to serious, comprehensive oversight. It should be unthinkable that investment banks like Bear or Lehman or other large firms like AIG could escape meaningful consolidated federal supervision. Under the Administration's proposal, this authority will be both robust and dynamic. The government must have the ability to collect information from all large financial firms to assess whether they could pose a threat to financial stability. The government must be able to impose reporting requirements on large financial firms and must be able to examine the books and records of any such firm to conduct this analysis. With this information, the government must then have the authority to subject all financial firms that present outsized systemic risks – regardless of whether they own an insured depository institution – to a common framework of supervision and regulation. And because financial markets constantly evolve, the government must regularly review its assessments of the systemic importance of firms. So the first part of our approach to the moral hazard problem is clear, accountable, comprehensive supervision. The second part is tougher standards. We must supervise our major financial firms more intensively and, after the financial system has had time to emerge from the recent crisis, we must hold these firms to tougher prudential standards than other firms, including tougher capital standards and tougher liquidity requirements. We also must focus our supervision and regulation of these firms on macro-prudential considerations – that is, on promoting the stability of the financial system as a whole – not just on micro-prudential aims of protecting the solvency of individual firms. Our plan for supervision and regulation that is both stricter and includes an additional focus on macro-prudential concerns will accomplish several goals. It will reduce the probability that our major financial firms will experience financial distress – either through capital depletion or a run by creditors – and therefore should reduce the likelihood of potential harm to the financial system by their failure or rapid deleveraging. In addition, our plan will force the major financial firms to internalize the externalities they generate – that is, to pay an appropriate regulatory price for the damage that their failure or distress could impose on the broader financial system. In doing so, it also will offset the perceived government support enjoyed by these firms, which should substantially reduce any competitive advantage they have due to https://www.treasury.gov/press-center/press-releases/Pages/tg306.aspx 2/4 5/13/2020 Assistant Secretary Michael S. Barr Remarks to the National Economists Club the market's assumption that they would receive assistance in the event of failure. These higher prudential standards will provide positive incentives for these firms to shrink and to reduce their leverage, complexity, and interconnectedness. The third key element of our response to the moral hazard problem is to strengthen the financial system so that it can, in fact withstand the failure of any firm. In this last crisis, it clearly was not. Weak financial institutions, systems, and market utilities can facilitate the propagation of shock waves from the failure of an individual financial firm throughout the financial system – with devastating effects. Leading up to the recent crisis, the shock absorbers that are critical to preserving the stability of the financial system – capital, margin, and liquidity cushions in particular – were inadequate to withstand the force of the global recession. In the banking system, we have proposed that prudential standards for all banking firms – including in particular capital and liquidity requirements – must be raised once the financial system has emerged from the recent financial crisis. In addition, we must identify specific activities that are linked to systemic stability or are highly correlated with the economic cycle and impose higher capital requirements on those exposures, even at the same level of expected risk. Another key way in which our proposal strengthens the resiliency of the financial market infrastructure is by providing for comprehensive regulation of OTC derivatives markets. The byzantine web of bilateral derivatives trades between the major financial firms allowed risk to build-up in these markets without oversight and this web of interconnections became a major source of contagion during the crisis. Therefore, we have proposed to require clearing of all standardized OTC derivatives through well regulated central counterparties. We also have proposed to require that all derivatives dealers and major market participants be subject to a robust regime of prudential supervision and regulation – a regime that includes conservative capital and initial margin requirements on all derivatives that are not cleared. Moreover, our proposal gives relevant financial regulators complete visibility into the derivatives markets through reporting requirements for both standardized and customized products – so that they can assess the extent to which derivatives trades might facilitate the transmission of localized or regional shocks throughout the financial system. Our proposals also address an often over-looked potential source of instability for markets -- the strength or weakness of arrangements for settling payment obligations and financial transactions between financial firms. Where such arrangements are strong, they can help guard against instability in times of crisis. Where they are weak, they can be a major source of financial contagion. Our proposals help ensure that the government has and exercises strong and consistent oversight authority over all critical payment, clearing or settlement systems and activities. The final step in addressing the problem of moral hazard is to make sure that we have the capacity – as we do now for banks and thrifts – to break apart or unwind major non-bank financial firms in an orderly fashion that limits collateral damage to the system. Bankruptcy is and will remain the primary method of resolving a non-bank financial firm. But as Lehman's collapse has showed quite starkly, there are times when the existing bankruptcy arrangements are simply not flexible enough, and bankruptcy courts not specialized enough, to deal with the insolvency of large financial institutions in times of severe crisis. We must have effective tools to manage the failure of major financial firms. Having such tools would help shrink moral hazard by reducing the probability that government intervention to preserve an individual firm would be needed to safeguard the viability of the financial system as a whole. At the same time, we must enhance market discipline by enabling the government to manage the resolution of troubled firms in a manner that imposes losses on firm stakeholders. To accomplish these goals, we have proposed to (i) create a special resolution regime that would give the government the authority to resolve in an orderly way financial firms whose failure would threaten financial stability; and (ii) require major financial firms to have workable rapid resolution plans. Under our proposed special resolution authority, the government would be able to seize control of the operations and management of a major financial firm that is in default or in danger of default, to act as a conservator or receiver for the firm, and to establish a bridge entity to effect an orderly sale of the firm or liquidation of its assets. In the main resolution authority is not about keeping these firms alive, it is about letting them fail – making sure that they fail in a way that causes less collateral damage to the economy and to the taxpayer. It is imperative that we minimize the risks that taxpayers pay the price of any future rescue of the financial sector. Therefore, under our proposal, any losses that might be incurred by the government in this special resolution process would be recouped through assessments on other large financial firms. We have also proposed to require our major financial firms to prepare and regularly update a credible plan for their rapid resolution in the event of severe financial distress. Since the failure of financial firms can happen suddenly through a rapid loss in confidence, the firm's management and home and host supervisors need detailed advance preparation. They need a roadmap laying out key decision points https://www.treasury.gov/press-center/press-releases/Pages/tg306.aspx 3/4 5/13/2020 Assistant Secretary Michael S. Barr Remarks to the National Economists Club and mechanics. A regularly updated, institution-specific, and internationally-coordinated resolution plan would accomplish these purposes. Bringing these plans into a supervisory framework will also have a more subtle but equally valuable effect: it will encourage firms to better monitor and simplify their organizational structures. During good times, financial disaster appears remote and receives minimal attention from management. That is why preparation for failure by a firm's management and supervisors must be institutionalized, routine, and thorough. The stakes are too high to do otherwise. We understand the need to coordinate regulation of major financial firms internationally to prevent geographic regulatory arbitrage. Financial firms, markets, and transactions have never been more globally mobile. The G-20 Leaders have acknowledged that we must raise safety and soundness standards for all major financial firms to consistently high levels. Together, these proposals give us a clear and credible argument that, as the President said two weeks ago in New York, "Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall." Thank you. ### https://www.treasury.gov/press-center/press-releases/Pages/tg306.aspx 4/4
@FedFRASER