CRS Issue Statement on Financial Regulatory Reform

Baird Webel, Coordinator
Specialist in Financial Economics

The financial regulatory system in the United States consists of a variety of regulators created at various historical times in response to different events. The resulting system is somewhat of a patchwork, with issues arising in the past involving coordination between regulators, and the possibility of "regulatory arbitrage" as regulated entities can choose regulators in some instances. Even before the recent financial crisis reached its height toward the end of 2008, some observers were calling for substantial reform of U.S. financial regulation, largely to improve the efficiency of the regulatory system. The financial crisis brought renewed focus to financial regulatory reform and substantially shifted the focus of reform to address the perceived causes of the crisis.

The financial crisis began with unexpectedly high mortgage defaults, particularly in subprime mortgages, which then resulted in falling values for securities backed by these mortgages. Credit rating agencies had previously rated such securities highly and they were generally perceived as unlikely to fall in value. Distrust of securities backed by assets spread beyond mortgage-backed securities and many large financial institutions that held or insured asset-backed securities found their survival threatened. Eventually the securitization market, which had grown over previous decades as the source of much of the credit available in the United States, largely ceased to operate. Financial derivatives, such as credit default swaps, acted essentially as an accelerant to the crisis. Derivatives both amplified the actual financial risk undertaken by some financial firms and spread uncertainty in the market due to a lack of information about what derivative positions were outstanding. Government entities, including the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Treasury, have taken a number of extraordinary steps to contain the crisis and rebuild financial markets in its aftermath.

In response the crisis, various proposals have been put forward to broadly reform the financial regulatory system, including legislation by House Financial Services Committee Chairman Barney Frank (H.R. 4173), House Financial Services Committee Ranking Member Spencer Bachus (H.Amdt. 539), and Senate Banking, Housing, and Urban Affairs Committee Chairman Christopher Dodd (an unnumbered committee print). As Congress moves forward considering policy proposals to reform financial regulation several different policy questions may be addressed. 

Specific Policy Questions 

How should Congress approach consumer protection in the financial sector? What role should regulators overseeing firm solvency play in protecting consumers? What should consumer protection entail? Should it focus on disclosure of financial product features and risks or on specific regulation of those features and risks?

How should Congress approach regulation for depository institutions (banks and thrifts)? Does the current system with multiple regulators need to be streamlined, or do multiple regulators provide important checks and balances?

Should Congress increase derivative oversight? Should derivatives be cleared through a central clearinghouse? Should they be traded on an exchange? Should there continue to be separation of the regulation of financial and commodity derivatives?

Should Congress increase the federal role in insurance regulation?

How should the failure of large, non-depository financial institutions be handled in the future? Should the FDIC or similar agency resolve such failures? Should they be handled through bankruptcy? If funding is need to resolve such failures, what would the source of funds be?

Should Congress increase regulation of large firms that might "too big to fail" prior to their failure? What entity should undertake this oversight? Should Congress attempt to prevent firms from becoming "too big to fail?" Could this be done through reinstituting some separation of financial functions (similar to the repealed Glass-Steagall Act) or through limits on financial firm size regardless of function, or through some other mechanism?

Does Congress need to increase investor protections? What rights should shareholders have to oversee managers, particularly with regard to executive compensation?

Does Congress need to regulate either the amount or method of executive compensation to decrease risk-taking by financial firms?

Does Congress need to change the oversight of credit rating agencies or their role in government policy?

Does financial regulation need to be harmonized between countries? If so, what steps could Congress take to promote international cooperation?


Date of Report: January 25, 2010
Number of Pages: 4
Order Number: IS40971
Price: $0.00 (This is the whole report less Issue Team Members)

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