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5/13/2020 Deputy Secretary Neal S. Wolin Remarks to the American Bar Association’s Banking Law Committee U.S. DEPARTMENT OF THE TREASURY Press Center Deputy Secretary Neal S. Wolin Remarks to the American Bar Association’s Banking Law Committee 11/13/2009 TG-404 Thank you Laurie, for that kind introduction and thank you all for the chance to speak with you today. Before I start, let me just say: I think many of you know Laurie, but for those of you who don't – Laurie is an incredible asset for the Treasury Department. We are very, very lucky to have her. She and her team are a constant source of invaluable expertise and judgment, and they've been right at the center of the reform effort that I'd like to talk about this morning. As you know, last summer President Obama put forward a comprehensive set of proposals to modernize our approach to financial regulation and to deal with the fundamental gaps and weaknesses that became so apparent in the financial crisis. In designing those proposals, and in the months since, the Administration has worked very closely with the House and the Senate – in particular, with Chairman Frank, Chairman Dodd, and the members of their respective committees. In the House, Chairman Frank has now passed through his committee substantial portions of a comprehensive package. The committee plans to complete its work in short order. In the Senate, Chairman Dodd just a few days ago released draft legislation for consideration by the Senate Banking Committee in the next few weeks. The legislation that has passed or that is under consideration in these committees reflects the core principles of the President's proposals. Both Committees are moving swiftly towards comprehensive reform. There is, of course, still much work to be done. And so I'd like to take this opportunity this morning to step back and look first at why these reforms are so essential – and then to focus, more specifically, on a question that has lately been at the center of the debate: the question of how to supervise the largest, most interconnected financial institutions – and how to limit the moral hazard associated with those institutions. Just over a year ago, the collapse of Washington Mutual, Wachovia, and Lehman Brothers, and the near-failure of AIG produced a financial panic of a scale not seen since the Great Depression. After a year of reflecting on the crisis and its causes, we must not forget how close we came to a complete financial collapse. At times last year, the fear was so intense that firms were unable to get short-term financing even by pledging US Treasury securities as collateral. The strongest, most stable U.S. commercial companies could not borrow to meet working capital needs. Money-market funds, among the safest of investment vehicles, saw massive investor flight. 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 741,000 - the worst in decades. Measured in jobs lost, measured in retirement savings lost, measured in homes foreclosed upon, measured in shuttered plants and struggling small businesses, the cost of the financial crisis for everyday Americans has been enormous. Unprecedented actions by Congress, the Fed, the FDIC and Treasury helped to prevent a truly catastrophic collapse. There are signs that we are now headed toward economic recovery. As the President has said, our work won't be done until every American who wants work can find work. But we have reported solid growth of 3.5 percent on an annual basis in the third quarter – with more growth projected for the fourth quarter and for 2010. The progress of recovery must not distract us, however, from the need for reform. Because while responsibility lies in many places, it is clear that the financial crisis and the economic destruction that followed were due, in large measure, to the failure of financial regulation. https://www.treasury.gov/press-center/press-releases/Pages/tg404.aspx 1/4 5/13/2020 Deputy Secretary Neal S. Wolin Remarks to the American Bar Association’s Banking Law Committee Our approach to regulation was – and is – outdated and ineffective. Protections for consumers were woefully inadequate. Key parts of the system went entirely or almost entirely un-regulated. Supervision of financial institutions was lax and inconsistent and capital requirements were too low. We did not have the tools to deal with the failure of large, interconnected firms that threatened the stability of the system as a whole. These weaknesses cannot be fixed piecemeal. As the crisis demonstrated all too clearly, what happens in one market – indeed, in one institution – can affect the stability of the system as a whole. That's why we have pushed for comprehensive reform. Take, for example, the weakness in our approach to consumer protection. In the years leading up to the crisis, millions of Americans were sold products they didn't understand and couldn't afford. No doubt, many households made irresponsible choices. But there's also no doubt that millions of people were misled by unclear disclosures, overly complicated contracts, or loan originators incented to close the deal without regard to the borrower's ultimate ability to pay. The result was tragic for the families who have lost their homes or who still struggle to carry crushing debts. And the result was also devastating for the economy as a whole. Through the market for asset backed securities, irresponsible mortgage lending destabilized the entire system – shaking the foundations of some of our nation's largest, oldest, most sophisticated financial institutions. To deal with the inadequacy of consumer protection, we've proposed the creation of a single agency – the Consumer Financial Protection Agency – that will write and enforce clear, straightforward, responsible rules of the road. The CFPA will help ensure that consumers have the information they need to make the responsible choices that are right for them. And it will help make the financial system as a whole more stable. Of course, the CFPA is just one part of the reform package. I'd like to talk now about how we have proposed to deal with moral hazard associated with our largest, most interconnected institutions – or, put another way, how we have proposed to end what some have called the problem of "Too Big to Fail." In recent decades, we've seen the significant growth of large, highly leveraged, and substantially interconnected financial firms. These firms benefited from the perception that the government could not afford to let them fail. Creditors and investors believed that large firms could grow larger, take on more leverage, engage in riskier activity – and avoid paying the consequences should those risks turn bad. It is a classic moral hazard problem. During the financial crisis, the federal government did stand behind almost all of these firms. That action was necessary, but there is no question that, unless we enact meaningful reforms, the fact that the federal government intervened this past year will have made the problem much worse. We take this moral hazard challenge very seriously. And our proposals address this problem, head on, in a number of ways. The biggest, most interconnected financial firms must be subject to serious, accountable, comprehensive oversight and supervision. The idea that investment banks like Bear or Lehman or other large firms like AIG could escape meaningful consolidated federal supervision should be considered unthinkable from now on. For the largest, most interconnected financial firms – for any firm whose failure might threaten the stability of the financial system – there must be clear, inescapable, single-point regulatory accountability. The scope of that accountability must include both the parent company and all subsidiaries. No regulator had a perfect record leading up to the crisis. But in our view, the Federal Reserve is the agency best equipped for the task of supervising the largest, most complex firms. The Fed already supervises all major U.S. commercial banking organizations on a firmwide basis. After the changes in corporate structure over the past year, the Fed now supervises all major investment banks as well. It is the only agency with broad and deep knowledge of financial institutions and the capital markets necessary to do the job effectively. In addition, the Fed's role as lender of last resort depends importantly on its supervision of the largest, most interconnected firms. Supervision gives it deep understanding and timely access to information about the banking sector, payments systems, and capital markets. Stripped of its supervisory role, the Fed would not have timely and complete information in a crisis. In addition to being subject to strong, consolidated supervision, the largest, most interconnected firms must be subject to tougher standards. Prudential requirements should be set with a view to offsetting any perception that size alone carries implicit benefits or subsidies. Capital and liquidity requirements must be higher for major firms, and they should be set at levels that compel firms to internalize the cost of the risks they impose on the financial system. Regulators should have the authority to break up or constrain the growth and activity of these firms, when their size or activities would pose a risk to the financial system. Firewalls between insured depository institutions and their affiliates should be strengthened. Risky activities – including in particular proprietary trading and sponsorship of off-balance sheet vehicles – should be subject to higher capital requirements. https://www.treasury.gov/press-center/press-releases/Pages/tg404.aspx 2/4 5/13/2020 Deputy Secretary Neal S. Wolin Remarks to the American Bar Association’s Banking Law Committee Through tougher prudential regulation, we aim to give these firms a positive incentive to shrink, to reduce their leverage, their complexity, and their interconnectedness. And we aim to ensure that they have a far greater capacity to absorb losses when they make mistakes. Beyond the heightened prudential requirements and enhanced regulatory authorities we've proposed, it is critical to emphasize that being among the largest, most interconnected firms does not come with any guarantee of support in times of stress. Indeed, the presumption must be the opposite: shareholders and creditors should expect to bear the costs of failure. And that presumption needs to have real weight. That means the financial system must be able to handle the failure of any firm. 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. While the largest firms should face higher prudential requirements than other firms, standards need to be increased system-wide. We've proposed to raise capital and liquidity requirements for all banking firms and to raise capital charges on exposures between financial firms. We've also laid out principles that we believe should guide regulators in setting capital requirements in the future. The core principle is that capital and other regulatory requirements must be designed to ensure the stability of the financial system as a whole, not just the solvency of individual institutions. Beyond that, we've called for a greater focus on the quality of capital. We've called for capital requirements that are more forward-looking and reduce pro-cyclicality. We've called for explicit liquidity requirements. And we've called for better rules to measure risk in banks' portfolios. We've also called for measures to strengthen financial markets and the financial market infrastructure. For example, we've proposed to strengthen supervision and regulation of critical payment, clearing, and settlement systems and to regulate comprehensively the derivatives markets. Our plan would require standardized derivatives to be centrally cleared and traded on an exchange or trade execution facility – substantially reducing the build-up of bilateral counterparty credit risk between our major financial firms. We would require all customized OTC derivatives to be reported to a trade repository, making the market far more transparent. We would provide for strong and consistent prudential regulation of all OTC dealers and all other major players in the OTC markets, including robust capital and initial margin requirements for derivative transactions that are not centrally cleared. We should never again face a situation – so devastating in the case of AIG – where the potential failure of a virtually unregulated major player in the derivatives market can impose risks on the entire system. Taken together, the significance of these reforms should be clear: by building up capital and liquidity buffers throughout the system, and by increasing transparency in key markets, our plan will make it easier for the system to absorb the failure of any given financial institution. The stronger the system, therefore, the clearer it will be that there is no such thing as an implicit government guarantee. In most circumstances, these precautions will be enough. More comprehensive oversight, combined with stronger capital and liquidity standards and the other measures we've proposed, will minimize the risk that the largest financial institutions will face failure. Moreover, in the event that they do fail, we believe that these actions will minimize the risk that any individual firm's failure will pose a danger to broad financial stability, which is why bankruptcy proceedings will remain the dominant option for handling the failure of non-bank financial institutions. The last two years, however, have shown that the U.S. government simply does not have the tools to respond effectively when failure could threaten financial stability. That is why our plan permits the government, in very limited circumstances, to resolve the largest and most interconnected financial companies outside of the traditional bankruptcy regime and consistent with the approach long taken for bank failures. This is the final step in addressing the problem of moral hazard. 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. The purpose of the special resolution regime would be to unwind, dismantle, restructure, or liquidate the firm in an orderly way to minimize costs to taxpayers and the financial system. All holders of tier 1 and tier 2 regulatory capital would be forced to absorb losses, and management responsible for the failure would be fired. If there are any losses to the government in connection with the resolution regime, these will be recouped from large financial institutions in proportion to their size. Our proposals represent a comprehensive, coordinated answer to the moral hazard challenge posed by our largest, most interconnected financial institutions: strong, accountable supervision; the imposition of costs, both to deter excessive risk and to force firms to better protect themselves against failure; a strong, resilient, well-regulated financial system that can better absorb failure, and a flexible resolution regime to enable the government to unwind major financial firms in a financial crisis in an orderly manner that protects financial stability, protects taxpayers – and makes shareholders and creditors shoulder the losses. https://www.treasury.gov/press-center/press-releases/Pages/tg404.aspx 3/4 5/13/2020 Deputy Secretary Neal S. Wolin Remarks to the American Bar Association’s Banking Law Committee Together, these proposals give us a clear and credible argument that, as the President said two months 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." Let me close by saying this: This is one of those rare moments when we have the chance to define the rules of the road for the next generation. The stakes are high. There is, of course, plenty of room for honest differences on the details of various plans. But there should be no disagreement about the urgency of reform. ### https://www.treasury.gov/press-center/press-releases/Pages/tg404.aspx 4/4
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