Remarks of John R. Dearie, Executive Vice President The Financial Services Forum, before the Spring Symposium of the University of Memphis School of Law

Thank you very much. And special thanks to interim Dean Kevin Smith and to Symposium Editor Jera Bradshaw for the invitation, their assistance, and hospitality.

I'm very happy to be with you today. The topic of your Symposium could not be more timely or relevant, and I'm very pleased to have been invited to participate.

Let me begin by evoking the standard disclaimer that the thoughts I share today are my own, and don't necessarily reflect the views of the Financial Services Forum or its members CEOs.

You know you are living in unusual times when financial supervision, and even certain accounting issues, have become cocktail circuit conversation. That may be overstating things a bit, but not by a lot.

After simmering on the policy back-burner for years, reform and modernization of our nation's framework of financial supervision has emerged as a top economic priority of the Obama Administration and the new Congress – and for very good reason.

For nearly 80 years, the United States was the world's premier capital marketplace, a status that amounted to an enormous strategic asset for the U.S. economy. Unfortunately, today, the U.S. financial system is the subject of global ridicule and even derision.

The subprime mortgage crisis and the financial upheaval it sparked have destroyed half a dozen venerable names of American finance, profoundly wounded half a dozen more, inflicted the worst year ever on global stock markets, wiped out $14 trillion in investor wealth, and ushered in what will almost surely be the longest and deepest recession since the Great Depression.

The search for culprits is well underway, and there is lots of blame to go around. Many factors and many parties had a hand in producing the crisis, including the financial industry itself, our regulators, policymakers – on both ends of Pennsylvania Avenue and on both sides of the aisle – and too many borrowers and consumers who made bad decisions. Sorting out why and how it all happened, and how we ensure that it never happens again, is a complicated task that will take time and careful thought.

It is, however, already widely acknowledged that the nation's outdated framework of financial supervision helped create the opportunity for the crisis. As everyone here is aware – and the reason we are gathered today – the current framework is a clunky Depression-era patchwork of regulatory fiefdoms with overlapping jurisdictions, varying statutory responsibilities and powers and, too often, inconsistent supervisory postures, priorities, and methodologies. These circumstances have led to needless duplication, confusion, regulatory arbitrage, structural imbalances, inefficiency, and waste. Worse, the balkanized nature of the current framework undermines regulators' ability to ensure institutional and systemic safety and soundness.

Now, let me pause for a moment and make a qualifying observation that I think merits keeping in mind. A moment ago I said that for nearly 80 years, the United States was the world's premier capital marketplace. I think it has to be acknowledged that our current framework of supervision had something to do with that.

Despite its flaws, drawbacks, and inefficiencies, until recently the system – for whatever reason, by hook or by crook – worked reasonably well.

That's not to say that reform is unneeded or unimportant. Quite the contrary. It is to suggest that there are – there must be – aspects of our current system that have served us well, and that if we can identify them we ought to preserve them.

An example of such a strength, in my view, is the dual banking system, which has facilitated diversity, inventiveness, and flexibility, and served as an invaluable restraint on any one regulator pursuing excessively rigid policies.

Still, as a general matter, we can do better. We must do better. If the United States is to reclaim its position of financial and economic leadership, our financial system needs a world-class, 21^st century supervisory framework

So what might such a framework look like? What would its parameters be, its structure, its objectives? As our first presenter this morning quite correctly pointed out, we can't intelligently answer that question, until we've answered two others:

First, what is it that is to be regulated? What is the modern financial system? What's its role in the economy? What do we need it to do for us?

Second, what is the point of regulation? What policy goals are we trying to accomplish through official oversight?

Only with good answers to these basic questions can we fairly and accurately identify the deficiencies of our current framework, and begin to get a sense of what a world-class, 21^st century framework might look like.

These questions are complex and deserving of their own Symposium and keynote address. But at the risk of oversimplifying, let me make a few quick observations about each.

Money and credit are the lifeblood of any economy's strength and well-being, enabling the investment, research, and risk-taking that fuels competition, innovation, productivity, and prosperity. With this basic notion in mind, the financial system – commercial banks, investment banks, insurance companies, pension funds, mutual funds, money market funds, and even hedge funds – can be though of as the institutional and technological infrastructure for the mobilization and allocation of that lifeblood. It is the cardiovascular system of the economy.

As a financial sector becomes more developed and sophisticated, capital formation becomes more effective, efficient, and diverse, broadening the availability of investment capital and lowering costs. A more developed and sophisticated financial sector also increases the means and expertise for mitigating risk – from derivatives instruments used by businesses to avoid price and interest rate risks, to insurance products that help mitigate the risk of accidents and natural disasters. Finally, the depth and flexibility of the financial sector is critical to the broader economy's resilience – its ability to weather, absorb, and move beyond the inevitable difficulties and adjustments experienced by any dynamic economy.

For all these reasons – and this is observation number 1 – an effective and efficient financial sector is the essential basis upon which the growth and vitality of all other sectors of the economy depend. It is the "force multiplier" for progress and development, amplifying and extending the underlying strengths of a growing economy.

Observation number 2: our modern financial system bears only a vague resemblance to the financial system that existed when the current supervisory architecture was put in place some 80 years ago. In the years since, stunning advances in computing and telecommunication technologies – and the heightened competition such advances give rise to – have driven a remarkable period of innovation leading to the development of ever more sophisticated financial instruments and techniques, including derivatives and securitization.

And make no mistake, such technologies and innovations are positive developments. They have reduced the cost of capital and of financial transactions, improved the allocation of financial resources, increased the competitiveness and efficiency of financial institutions and markets, and opened new avenues through which businesses and individuals can better diversify, hedge, and manage risk.

Without doubt, that's progress.

But there is also little doubt that with this progress has also come significant dangers. The rapid pace of technological advancement and financial innovation has introduced new, highly complex elements of risk, blurred the barriers between previously distinct sectors of the financial marketplace, increased the speed and volatility of the markets, and rendered geographic boundaries virtually meaningless.

Which brings me to observation number 3: the modern financial marketplace is global. While sovereign nations and national jurisdictions still matter in a legal sense, capital knows no boundaries. It is raised in one corner of the globe and lent in another. Even individual transactions can and do cross national borders – originating in one country, booked in another, and managed in a third.

So what do these few observations about our modern financial system mean for the purpose and objectives of supervision?

For starters, if money and credit are the lifeblood of the economy, and if the financial sector is the cardiovascular system of the economy – the essential sector upon which the growth and vitality of all others depend – it follows that the supervisory framework must be one that allows this critical function to be performed, and performed well.

This may seem like an obvious point. But it's a point worth making, and making often, in light of the current atmosphere on Capitol Hill.

Congress, as many of you know, has a short memory and tends to legislate in response to the latest crisis. It's not surprising, then, that ensuring financial stability has become the principle focus of the reform debate on Capitol Hill. How do we make sure that such a terrible crisis never happens again? Add to that the understandable anger felt by millions of American constituents, and the risk becomes that supervisory reform will be about punishing the financial sector – trapping it in a regulatory cage.

Such an outcome would be very dangerous, with far-reaching consequences for the U.S. and global economies. Having the world's largest, deepest, most sophisticated and competitive capital marketplace within our national borders has generated enormous benefits for American businesses, workers, savers, and investors. For savers and investors – a group that includes half of all American households – such benefits include a wider range of investment alternatives, highly efficient pricing, and greater liquidity. For issuers of securities, benefits include a larger shareholder base, enhanced corporate prestige, and a lower cost of capital – which directly translates into more research and risk-taking and, therefore, greater innovation, higher productivity, stronger economic growth, and faster job creation.

Though understandable, it's more than a little ironic that the priorities of innovative capacity and competitiveness have taken a back seat to financial stability. As many of you might recall, just two years ago the driving force behind the regulatory reform debate was concern about the waning competitiveness of the U.S. capital markets.

In the introduction to the McKinsey & Co. report they commissioned on the waning competitiveness of New York's capital markets, New York Mayor Michael Bloomberg and New York Senator Chuck Schumer wrote: "The 20^th century was the American century in no small part because of our economic dominance in the financial services industry…all Americans have a vested interest in strengthening the industry."

This observation is just as relevant and important today as it was twenty-seven months ago.

And yet, having said that, a major objective of financial supervision has to be ensuring safety and soundness. After all, a capital marketplace cannot be world class, it cannot be competitive, if it is prone to the sort of debilitating crisis we're currently experiencing.

The first line of defense against financial instability is the rigor and effectiveness of internal controls and risk management within financial institutions. But official oversight has a role to play as well. The economic role of financial institutions is to take risks prudent, calculated risks. And the supervisor's job is to help ensure that the risks being taken are prudently and effectively managed.

An important part of ensuring safety and soundness – and of competitiveness for that matter – is protecting the rights and interests of depositors and savers. Without their trust and confidence, there is no financial system.

Given the technology-driven complexity, speed, and volatility of the modern financial system, an ideal supervisory framework must also be nimble, flexible, and responsive to the activities, innovations, and risks of the world's most dynamic capital marketplace if it is to have a fighting chance of ensuring safety and soundness.

Ideally, the supervisory framework should also be efficient and cost effective. Our current system is not. Howell Jackson of Harvard Law School has estimated that gross financial regulatory costs to U.S. taxpayers – even after adjusting for differences in GDP – are more than six times greater than in the United Kingdom. Other industry experts have estimated that regulatory costs to American financial institutions are 15 times higher than in the United Kingdom. No doubt most of this burden is the result of substantial supervisory overlap and duplication.

Contrary to what some in Congress would have you believe, the problem is clearly not a lack of regulation – and, therefore, the solution cannot be simply more regulation.

In response to the burden of costly overlap, duplication, and inconsistencies, some have recommended total consolidation of our current framework. If the problem is too many regulators bumping into each other, the thinking goes, the obvious solution is to merge the exiting regulators into a single agency.

It's my view that the single regulator solution is no solution at all. Monopoly is rarely a good idea – perhaps least of all in a regulatory context. Any purported efficiencies of a single regulator would be far outstripped by the problems typically associated with monopoly, including inflexibility, institutional arrogance, and unresponsiveness. Simply put, do we really want our financial sector presided over by the supervisory equivalent of the Department of Motor Vehicles?

In this regard, it's worth noting that in May of 2001, a survey of officials at 70 financial institutions in the United Kingdom – both headquartered in the UK and foreign institutions with business operations there – regarding the effectiveness of the much-touted FSA, revealed that many regarded the FSA as "bureaucratic, intrusive and insensitive," a reality so severe that many expressed concern it might eventually undermine the City's international competitiveness. [1]

Finally, the ideal supervisory framework must be globally integrated. Financial markets are global and so are financial crises. Harmonization of international supervisory and accounting standards, greater information sharing, and more frequent and robust cross-border cooperation will greatly enhance the effective and efficient functioning of global capital markets, as well as official crisis response efforts.

So with all this in mind, the outlines – the characteristics – of an ideal supervisory framework begin to emerge:

• It must ensure systemic stability and institutional safety and soundness, as well as protect the interests of depositors and investors – while at the same time tolerating and even promoting the innovative capacity and competitiveness of this essential industry;
• It must be uniform enough to oversee in a consistent, "level playing field" sort of way an industry that has undergone tremendous product, activity, and risk convergence – while at the same time preserving sufficient regulatory specialization and expertise to adequately address the needs, activities, and risks of varying classes of financial entities;
• It must be much more streamlined and rational to eliminate the cost, burden, and confusion of unnecessary regulatory overlap and duplication – while at the same time preserve a degree of regulatory competition and avoid the very real and significant drawbacks of regulatory monopoly.

Just hearing the "on-the-one-hand-on-the-other-hand" nature of the desired framework, one gets the very palpable sense of just what a difficult policy nut this is to crack. But if we can effectively and credibly achieve each of these varying priorities – properly balanced – we would be, in my judgment, very close indeed to a truly world-class, 21^st century framework of supervision.

But how to do it? What kind of specific reform arrangement would achieve the best approximation of all of these varied and competing priorities?

Fortunately, there's no need for policymakers to start from scratch. A simple yet compelling reform model already exists that, if merely expanded, would, in my view, accomplish all of the advantages of the much-discussed single regulator model – promoting greater regulatory efficiency and consistency, achieving consolidated oversight of all U.S. financial institutions, and establishing a systemic supervisor – while avoiding the well-known drawbacks of regulatory monopoly.

The Gramm-Leach-Bliley Act of 1999 repealed the "Glass-Steagall" provisions of the Banking Act of 1933, permitting well-managed and well-capitalized financial institutions to become "financial holding companies" ("FHCs") and to engage in a diversified range of financial activities.

GLBA also created a new regulatory arrangement for the effective supervision of FHCs – designating the Federal Reserve as their "umbrella" supervisor, with the OCC, the 50 state banking departments, the SEC, and the 50 state insurance authorities serving as the "functional regulators" of the banking, securities, and insurance subsidiaries of the Fed-supervised FHCs.

GLBA specifically prohibits the Fed from conducting on-site examinations of the non-bank subsidiaries of FHCs, except under extreme circumstances. Rather, the Act stipulates that the Fed must rely "to the fullest extent possible" on examination reports and other relevant information provided by the functional regulators.

If you think about it, an FHC looks a lot like a mini-financial system – with commercial banking, investment banking, insurance, and perhaps other financial-related subsidiaries arranged within a holding company structure. This observation suggests a simple but rather compelling reform alternative – expand or extend GLBA's two-tiered framework of "umbrella supervision" and "functional regulation" from only FHCs currently to all financial institutions. Doing so, in my view in any case, would effectively address all of the previously known deficiencies of the current supervisory apparatus, as well as the major issues raised by the current crisis.

Call it "GLBA-Plus."

The model envisions consolidating the on-site examination responsibilities of the four existing Federal banking agencies – the Federal Reserve, OTS, FDIC, and OCC – within the OCC, which would become the single Federal banking agency with on-site examination powers. The OTS would be fully incorporated into the OCC – both are Treasury Department agencies and have similar cultures.

The FDIC would continue to administer the deposit insurance fund, but would no longer examine banks on site. Instead, it would rely on the examination reports and other relevant information generated by the OCC.

The Federal Reserve would also no longer conduct on-site examinations of banks, but would retain its umbrella oversight of bank holding companies, including FHCs. Indeed, its umbrella oversight authority would be extended to include all U.S. banks, securities firms, and insurance companies.

The designation of the Fed as the financial system's true umbrella or "systemic" supervisor stems in large part from its unique powers as the monetary authority and lender-of-last-resort, tools that enable the Fed to reach into financial markets and alter fundamental conditions – the agency to which all financial institutions and market participants look in time of crisis.

Importantly, the Fed would not have the authority to examine banking, securities, or insurance subsidiaries on site – except in emergency circumstances. Instead, it would rely on the OCC, the SEC (free standing or consolidated with the CFTC), the 50 state banking departments, the 50 state insurance authorities, and a newly created Federal insurance authority for examination reports and other relevant information – in the same manner that it has relied on the functional regulators under the GLBA regime.

It's important to note that in this regard the Fed has proven that it can be trusted – in the thousands of examinations of FHCs conducted since GLBA was passed in 1999, the Fed has never pushed a functional regulator aside to examine a subsidiary, banking or otherwise, on site.

In addition to its simplicity and conceptual appeal, the GLBA-Plus model offers a number of significant advantages pursuant to the priorities of world-class supervision that we've identified.

First, by merging the OTS into the OCC, and consolidating the on-site examination powers – the most onerous and costly aspect of supervision – of the remaining Federal banking agencies into the OCC, GLBA-Plus would generate tremendous efficiencies and cost savings, to the benefit of the industry and the American taxpayer.

Second, by establishing the Fed as the true umbrella or "systemic" supervisor, the model provides for oversight of the financial system in totality. Supervisory inconsistencies across industry sectors, insufficient regulatory cooperation, and a "stove-piped" regulatory structure – no authority looking at the big picture – all contributed to the current crisis. A more seamless, consistent, and holistic approach to supervision is necessary to ensure systemic stability and the safety and soundness of all financial entities.

Third, the Fed is already an umbrella supervisor. It has supervised bank holding companies since 1956, and following enactment of GLBA has developed significant additional expertise overseeing financial conglomerates that include banking, securities, and insurance entities. Moreover, as you know, in recent months a number of major non-bank financial institutions – including Goldman Sachs, Morgan Stanley, American Express, and even GMAC – have become bank holding companies and submitted to consolidated oversight by the Fed.

Fourth, the Fed's role as the true umbrella supervisor would be to assess from the holding company level (relying on the functional regulators for detailed subsidiary information), the consolidated condition, activities, capital adequacy, risk management, internal controls, corporate governance, and overall safety and soundness of all financial institutions – providing comprehensive, top-down oversight of every financial institution.

Fifth, requiring the Fed to rely on the functional regulators to conduct on site examinations – again, the most onerous aspect of financial regulation – would substantially mitigate potential concern regarding the expansion of the Fed's supervisory purview to include all U.S. financial institutions.

Sixth, by incorporating most existing regulatory agencies (eliminating only the OTS), and retaining the state-Federal option of functional regulation, the GLBA-Plus model preserves regulatory specialization, as well an appropriate degree of regulatory competition and innovation, thereby avoiding the inflexibility and unresponsiveness typically associated with concentrated regulatory power.

Seventh, a major aspect of the Fed's role as the umbrella supervisor would be to coordinate greater cooperation among the other regulatory agencies, thereby improving supervisory consistency and effectiveness and a more unified, coherent, and transparent rulemaking process.

Eighth, because the Fed is a principles-based supervisor, its coordination of the other regulatory agencies would promote a comprehensive shift toward a more principles-based approach to supervision.

Ninth, as the umbrella supervisor of the U.S. financial system, the Federal Reserve would be assigned the role of spearheading and managing international harmonization and cooperation efforts.

And finally, but significantly, by simply extending an already existing framework with which the industry, regulators, and Congress are already familiar from FHCs to the entire financial system, GLBA-Plus would be much easier politically than creating new agencies with new powers from scratch.

I'll conclude by acknowledging that change can be difficult and can cause significant anxiety – even change that virtually everyone agrees is necessary and overdue. But reform and modernization of U.S. financial supervision is both possible and desirable.

For decades our financial system has remained the world's leader despite the costs, burdens, and deficiencies of an outdated supervisory framework. We can no longer afford such a significant competitive drag and threat to safety and soundness.

By preserving the diffusion of regulatory power, while achieving significant rationalization and a much more efficient, consistent, and comprehensive supervisory framework, the GLBA-Plus model – in my judgment – strikes the balance between the strengths of our current framework and badly needed, long-overdue reform.

As a result, the safety and soundness, and competitiveness, of the U.S. financial system would be greatly enhanced – and investors and depositors would have the protection and piece of mind they deserve.

Thank you very much for inviting me and for listening.