DATE: JANUARY 9, 2009

TO: NCOIL LEGISLATORS

FROM: MIKE HUMPHREYS, NCOIL

RE: GAO REPORT CRITIQUES FINANCIAL REGULATORY SYSTEM, MIXED REVIEW ON OPTIONAL FEDERAL CHARTER (OFC)

Below are links to the following information:

  • GAO Financial Regs Report Says Congress Should Look at OFC (1/8 National Underwriter)
  • GAO Report on Financial Regulation (1/2009 GAO)
  • NCOIL Letter to New Members of Congress (1/9 NCOIL)

Yesterday afternoon the U.S. Government Accountability Office (GAO) released a report to Members of Congress entitled “Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System.”

GAO REPORT

According to its authors, the report’s “primary focus is on discussing how various market developments have revealed gaps and limitations in the existing regulatory system.” It contained broad sections that (1) address the history of U.S. financial regulation; (2) review market developments and changes that have challenged the system; and (3) offer a framework for federal policymakers to craft or evaluate reform proposals.

The GAO authors write, in a January 8 letter to Congress that’s starts off the report:

The current U.S. regulatory system has relied on a fragmented and complex arrangement of federal and state regulators—put in place over the past 150 years—that has not kept pace with the major developments that have occurred in financial markets and products in recent decades.

COMMENTARY

Release of the GAO report comes around the same time that NCOIL hand-delivered a letter to new Members of Congress outlining the strengths of state-based insurance regulation. The NCOIL letter—distributed this afternoon—also offers our assistance as new Members consider regulatory reform initiatives.

The GAO report contains little new information—instead, it provides background on the U.S. regulatory system and declares that regulation has not kept pace with an evolving marketplace. On a positive note, the report hardly addresses insurance regulation and mentions an optional federal charter (OFC) in one short paragraph—neither endorsing nor opposing the OFC concept (see below).

With that said, we know that new Congress and administration will emphasize financial services regulatory reform this year. The GAO will issue an insurance-specific report—looking at market conduct, producer licensing, and product approval—in April, around the same time that the Department of the Treasury will release a second paper on regulatory reform, as required by federal bailout legislation.

SECTION ONE: HISTORY OF U.S. FINANCIAL REGULATION

The report states that:

Overall, responsibilities for overseeing the financial services industry are shared among almost a dozen federal banking, securities, futures, and other regulatory agencies, numerous self-regulatory organizations (SRO), and hundreds of state financial regulatory agencies.

The report says that the regulatory system “was built over more than a Century, largely in response to crises or market development.” The section contains brief summaries of how the current regulatory structure for banking, securities, insurance, futures, and other industries has developed during the past 150 years—focusing on how major crisis have sparked reform.

Examples include: the National Bank Act (1863, post Civil War), the Securities and Exchange Act (1929, post stock market crash), the McCarran-Ferguson Act (1945, in response to U.S. Supreme Court decision that insurance was subject to interstate commerce laws).

SECTION TWO: MARKET DEVELOPMENTS/CHALLENGES TO THE SYSTEM

The report addresses developments in financial markets and products in the last 50 years that pose challenges to the current regulatory system, including:

  • the rise of globally active financial services conglomerates—due in part to waves of corporate mergers—and the ability to regulate them
  • the emergence of large and sometimes less-regulated market participants, such as hedge funds and credit rating agencies
  • the development of new and complex products and services (collateralized debt obligations and credit default swaps, among others)
  • globalization, and the ability of U.S. regulators to coordinate with international regulators

SECTION THREE: FRAMEWORK

The report develops a nine-element framework for Congress and others to use when considering options for reform. Authors of the report emphasize that they are not proposing the structure or details of a new system. The framework supports:

1. clearly defined regulatory goals

2. appropriate comprehensiveness

3. systemwide focus

4. flexibility and adaptability

5. efficiency and effectiveness

6. consistent consumer and investor protection

7. regulators provided with independence, prominence, authority, and accountability

8. consistent financial oversight

9. minimal taxpayer expense

The report says recent reforms have responded to the immediate nature of the various financial crises but suggests that without a comprehensive reform effort, the U.S. regulatory system will fail to forestall future economic troubles.

OPTIONAL FEDERAL CHARTER

The 60-plus page report includes one reference to OFC legislation—and its review of the proposal is mixed. Instead of advocating for an OFC, the report states that Congress could consider it, and then discusses its possible pros and cons. The authors wrote:

Congress could consider the advantages and disadvantages of providing a federal charter option for insurance and creating a federal insurance regulatory entity. We have not studied the issue of an optional federal charter for insurers, but have through the years noted difficulties with efforts to harmonize insurance regulation across states through the NAIC-based structure. The establishment of a federal insurance charter and regulator could help alleviate some of these challenges, but such an approach could also have unintended consequences for state regulatory bodies and for insurance firms as well.

Please feel free to contact me by reply e-mail or at 202-220-3014 should you have any questions.