Filling Gaps and Black Holes: Restructuring the Financial Regulatory Apparatus for the Next Crisis (Written Testimony for the Senate Homeland Security and Governmental Affairs Committee Hearing on the Adequacy of the U.S. Financial Regulatory System)

Abstract

The current financial regulatory system is fractured and archaic. In my testimony I recommend that Congress consolidate the present system into three regulators: a financial markets regulator, bank capital regulator and systemic risk regulator. To the extent full financial integration is not politically achievable, Congress should create regulatory champions in each of these three areas who can dominate the remaining other regulators and grow and absorb them or their responsibilities over time. Any regulatory reform must also encompass the entirety of the financial system. It cannot leave gaps, black holes (i.e., deliberately unregulated areas) or financial institutions without potential oversight. To do otherwise would allow for regulatory arbitrage. In particular, any systemic risk regulator should have potential over the entire financial market and all financial institutions, including insurance companies, should be subject to financial regulatory oversight. Here, I emphasize that when I speak of providing oversight responsibility over the entire financial system, it does not necessarily equate with heightened substantive regulation, but the potential for regulation if a regulator exercising its prudent authority deems it appropriate. Congress should additionally build flexible regulators and a sustainable financial architecture but should leave the details of specific rules to be filled in by the selected regulator. Otherwise, Congress risks erecting rules that are either not adaptable to future changes or are not fully informed by later research on the financial crisis and our capital markets. In particular, Congress should require cost-benefit analysis for any rule-making by these new agencies.