New York City Mayor Michael Bloomberg yesterday called for an overhaul of the financial regulatory system, telling industry executives that previous methods have struggled to keep up with pace of innovation in recent years.
The market needs consistency in regulation, transparency by financial firms, and a global vision as it seeks to restore confidence and trust, Bloomberg told attendees at the Securities Industry and Financial Markets Association's annual meeting in New York. The increasingly blurred lines between different types of financial institutions have made the old system an ineffective "relic," he said.
"What came out of it was a painfully inadequate patchwork system, with some agencies overlapping unnecessarily, while at the same time, major areas in the financial markets going unregulated," Bloomberg said.
He suggested that the markets may need a "financial stability regulator" that has access to information from all types of financial institutions, such as banks, hedge funds, and insurers. Bloomberg praised Treasury Secretary Henry Paulson, but also said he believed the decision to let Lehman Brothers Holdings Inc. fail created "terrible" consequences for the economy.
Bloomberg singled out credit-defaults swaps as one financial instrument designed to avoid regulatory oversight. Although technically a form of insurance, the CDS went unregulated, allowing financial institutions to essentially gamble on the market rather than using the CDS to fulfill their purpose of spreading risks.
The increased use of "custom-made securities" with difficult to value underlying assets increased uncertainty, with even some managers of financial companies failing to understand their risks, Bloomberg said. In some cases, products and institutions went without proper regulation because they were too difficult to understand, he said.
"And I think we've just had a powerful lesson in how dangerous that can be," the mayor added.
Industry leaders later agreed with the need for some regulatory overhaul while defending their own positions. SIFMA chairwoman and JPMorgan's head of commodities Blythe Masters, sometimes considered the inventor of CDS, said it was not the CDS themselves that failed, but rather the subprime instruments underlying the swaps. She cited the successful settlement of Lehman Brothers CDS last week as proof that the CDS system worked as intended.
Still, the financial industry's image is at an "all-time low" and regulatory changes are needed, Masters said. She suggested measures, such as consolidating existing regulators - for instance the Office of Comptroller of the Currency and Office of Thrift Supervision - while cautioning against the push some states have made to regulate markets are their own.
"Our outdated regulatory framework has been called a patchwork quilt," Masters said. "It seems like there are a lot more holes than patches in the quilt."
At a later panel, regulatory experts discussed possible ways to reform the regulatory framework, mostly agreeing a massive overhaul is needed immediately - perhaps even sooner than Congress or the next president's administration could do it. Panelists suggested the need for consolidation of many different agencies with a convergence of standards and rules, in addition to increased coordination and information sharing between any that remain.
"We have a unique opportunity to look at the entire regulatory scheme now," said Mary Schapiro, the chief executive officer of Financial Industry Regulatory Authority.
Randall Guynn, a partner at law firm Davis Polk & Wardwell, suggested a system with two regulatory bodies: one with oversight of a broad range of financial firms and an ability to gather information to see the "big picture," and another to regulate systemically important institutions, such as primary dealers, large insurance companies, and certain hedge funds.
Former Securities and Exchange Commissioner chairman Harvey Pitt, now at Kalorama Partners LLC, said regulators were not given the tools necessary to oversee financial institutions that were given increasingly more power. Regulators need more access to information and more tools to immediately tackle problems, he said.
Pitt considers SEC functions like enforcement vital, but said enforcement is only needed when regulation has already failed. He also said private sector regulation worked well in the past and should be a part of any plan moving forward.
Participants also raised the possibility of an optional federal insurance charter, an idea Congress and the Department of Treasury both have said they were considering earlier this year. Insurance regulation, including that for financial guarantors, currently occurs at the state level.
