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Loan originators failed to require sufficient documentation of income and ability to pay. Securitizers failed to set high standards for the loans they were willing to buy, encouraging underwriting standards to decline. Investors were overly reliant on credit rating agencies. Credit ratings often failed to accurately describe the risk of rated products. In each case, lack of transparency prevented market participants from understanding the full nature of the risks they were taking. The build-up of risk in the over-the-counter (OTC) derivatives markets, which werethought to disperse risk to those most able to bear it, became a major source of contagion through the financial sector during the crisis.We propose to bring the markets for all OTC derivatives and asset-backed securities into a coherent and coordinated regulatory framework that requires transparency and improves market discipline. Our proposal would impose record keeping and reporting requirements on all OTC derivatives. We also propose to strengthen the prudential regulation of all dealers in the OTC derivative markets and to reduce systemic risk in these markets by requiring all standardized OTC derivative transactions to be executed in regulated and transparent venues and cleared through regulated central counterparties.We propose to enhance the Federal Reserve’s authority over market infrastructure to reduce the potential for contagion among financial firms and markets.
Filippo Cardone Site Finally, we propose to harmonize the statutory and regulatory regimes for futures and securities. While differences exist between securities and futures markets, many differences in regulation between the markets may no longer be justified. In particular, the growth of derivatives markets and the introduction of new derivative instruments have highlighted the need for addressing gaps and inconsistencies in the regulation of these products by the CFTC and SEC.Prior to the current financial crisis, a number of federal and state regulations were in place to protect consumers against fraud and to promote understanding of financial products like credit cards and mortgages. But as abusive practices spread, particularly in
the market for subprime and nontraditional mortgages, our regulatory framework proved inadequate in important ways. Multiple agencies have authority over consumer protection in financial products, but for historical reasons, the supervisory framework for enforcing those regulations had significant gaps and weaknesses.
The CFPA should use survey methods to determine whether consumers who obtained the product type in the marketplace demonstrated awareness and understanding of the product and its risks, such as the risk of payment shock and of the balance exceeding the value of the house. The CFPA should also consider access to credit and costs to consumers of stricter regulations. The CFPA should be authorized to use a variety of measures to help ensure alternative mortgages were obtained only by consumers who understood the risks and could manage them. For example, the CFPA could impose a strong warning label on all alternative products; require providers to have applicants fill out financial experience questionnaires; or require providers to obtain the applicant’s written “opt-in” to such products. Originators and purchasers of “plain vanilla” mortgages should enjoy a strong presumption that the products are suitable and affordable for the borrower. OriginatorsIn recent years, the principle that product and service providers should treat consumers fairly has been too often honored only in the breach. The mortgage and credit card markets have demonstrated convincingly the need for rules that require fair contracts and practices and remove or reduce perverse and hidden incentives to take advantage of
consumers. The excessive complexity of many mortgage products created an opportunity to take advantage of consumers’ lack of awareness and understanding of product risks.
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Fourth, investment banks operated with insufficient government oversight. Money market mutual funds were vulnerable to runs. Hedge funds and other private pools of capital operated completely outside of the supervisory framework.To create a new foundation for the regulation of financial institutions, we will promote more robust and consistent regulatory standards for all financial institutions. Similar financial institutions should face the same supervisory and regulatory standards, with no gaps, loopholes, or opportunities for arbitrage.We propose the creation of a Financial Services Oversight Council, chaired by Treasury, to help fill gaps in supervision, facilitate coordination of policy and resolution of disputes, and identify emerging risks in firms and market activities. This Council would include the heads of the principal federal financial regulators and would maintain a permanent staff at Treasury.The tools available to Treasury should include the ability to establish conservatorship or receivership for a failing firm. The regime also should provide for the ability to stabilize a failing institution (including one that is in conservatorship or receivership) by providing loans to the firm, purchasing assets from the firm, guaranteeing the liabilities of the firm, or making equity investments in the firm. We propose that, in choosing among available tools, Treasury should consider the effectiveness of an action for mitigating potential adverse effects on the financial system or the economy, the action’s cost to the taxpayers, and the action’s potential for increasing moral hazard.The conservator or receiver of the firm should have broad powers to take action with respect to the financial firm. For example, it should have the authority to take control of the operations of the firm or to sell or transfer all or any part of the assets of the firm in receivership to a bridge institution or other entity. That should include the authority to transfer the firm’s derivatives contracts to a bridge institution and thereby avoid termination of the contracts by the firm’s counterparties (notwithstanding any contractual rights of counterparties to terminate the contracts if a receiver is appointed). The conservator or receiver should also have the power to renegotiate or repudiate the firm’s contracts, including contracts with its employees. In 1988, the BCBS developed the Basel Accord to provide a framework to strengthen banking system safety and soundness through internationally consistent bank regulatory capital requirements.
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