Next Steps in Financial Regulatory Reform
Governor Daniel K. Tarullo
At the George Washington University Center for Law, Economics, and Finance Conference on the Dodd-Frank Act, Washington, D.C.
November 12, 2010
~~~
Thank you very much for your invitation to speak at this second annual symposium on financial regulatory reform. Before addressing that topic, I want to say a word about the mortgage foreclosure documentation imbroglio, the latest chapter in the recent sad history of mortgage finance in this country.
The Need to Increase Mortgage Modifications
As you know, inquiries into the extent of, and culpability for, these problems are currently being conducted by banking regulators, other federal agencies, and state attorneys general. Regardless of the findings that emerge, and the steps that servicers and others may take to correct their mistakes, this episode has again drawn attention to what can only be described as a perverse set of incentives for homeowners with underwater mortgages. Homeowners who try to get a modification of the terms of their mortgages are all too frequently subject to delay and disappointment. On the other hand, those who simply stop paying their mortgages have found that they can often stay in their homes for a year or more, rent free, before the foreclosure process moves ahead.
This simply is not a good outcome from any broad perspective–not for the revival of housing markets, not for the banks and investors that hold the delinquent mortgages, and in the longer run, not even for the homeowners themselves, who will ultimately have to move out, taking with them a dark cloud over their creditworthiness.
Several possible explanations have been suggested for this untoward state of affairs–the lack of servicer capacity to execute modifications, purported financial incentives for servicers to foreclose rather than modify, what until recently appeared to be easier execution of foreclosures relative to modifications, limits on the authority of securitization trustees, and conflicts between primary and secondary lien holders. Whatever the merits and relative weights of these various explanations, the social costs of this situation are huge. It just cannot be the case that foreclosure is preferable to modification–including reductions of principal–for a significant proportion of mortgages where the deadweight costs of foreclosure, including a distressed sale discount, are so high. While some banks and other industry participants have stepped forward to increase the rate of modifications relative to foreclosures, many have not done enough. I would hope that both servicers and ultimate holders of the mortgages will take this occasion not just to correct documentation flaws and to contest who should bear the losses of mortgages gone bad, but to invigorate the modification process.
Next Steps Down the Reform Road
I note that while last year’s conference was called “Regulatory Reform at the Crossroads,” this year’s event is entitled “The Dodd-Frank Act and the Road Ahead for Financial Regulatory Reform.” The metaphor of a long road ahead following key decisions in Dodd-Frank is an apt one for the Federal Reserve and other regulatory agencies that will, over the next 15 to 20 months, complete implementation of that bill through scores of regulations. The metaphor also applies to elaboration and domestic implementation of the framework for Basel III that was agreed to internationally in September.
Though we may no longer face a major crossroads, the federal banking agencies will certainly encounter numerous forks in the road we are travelling. Choices will be presented during implementation of certain Dodd-Frank provisions that set a general direction for change, but do not mandate a precise route. Others will be encountered as we continue the Basel III exercise, to which I will return in a moment. Still other choices will doubtless be required as all the member agencies of the new Financial Stability Oversight Council evaluate and, potentially, respond to developments in financial markets. Finally, at least one big crossroad still lies ahead–a decision on the future of the government-sponsored housing finance agencies.
We are, of course, in the middle of the Dodd-Frank implementation process. Thus, while I recognize there is enormous interest in where the Federal Reserve and other rule-writing agencies may be headed, I cannot say much about the substance of the regulations that will eventually be proposed and adopted. Indeed, I think it would be inconsistent with the very purpose of administrative law requirements for me to come to my own conclusions, much less opine publicly on them, before we have made our proposals and evaluated all the comments.
What I can say is that, in implementing Dodd-Frank, the Board of Governors will be guided by the same norms of statutory construction that a court would apply. Most importantly, where Congressional intentions are clear from the language of the statute, we must faithfully execute those intentions. Of course, there are a good many provisions that do not admit of a single interpretation, and the implementation of those provisions will require the exercise of discretion by the Federal Reserve or other regulatory agencies.
I can also say that we are following a transparent and inclusive process that goes well beyond the classic notice and comment requirements for agencies adopting regulations. As to transparency: At the Federal Reserve, we are entering into the public record a summary of all communications with non-government groups or individuals regarding matters subject to a potential or proposed rulemaking under Dodd-Frank. As to inclusiveness: We have joined with the other banking agencies in sponsoring a series of joint forums to solicit views from industry, academics, and others on some key issues relevant to Dodd-Frank implementation. We are also hearing views on regulatory implementation at meetings that cover a broad range of topics, such as at our last Consumer Advisory Council session.
Reforming Minimum Capital Requirements
Although they had long used bank capital ratios as a supervisory tool, U.S. bank regulators did not impose explicit minimum capital requirements until the 1980s. The proximate reason for this change was regulatory concern over the decline in capital ratios of the largest banks–a concern reinforced by Congress, as it saw some of those large banks facing enormous losses on their loans to foreign sovereigns. This U.S. regulatory innovation was effectively internationalized a few years later in the original Basel Accord.
Read the rest of this entry »
Tweet
Facebook
Reddit
Digg this!
