Eugene Ludwig: 7 Keys to Financial Regulation

Former top bank regulator outlines the keys to a successful financial regulatory framework.

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Speaking Thursday at a Senate Banking Committee hearing, Eugene Ludwig, a former comptroller of the currency, outlined his seven key elements for a successful financial regulatory framework.

From Ludwig's testimony:

It is clear that the deregulatory mantra of the last decade is dead. The real question is how far do we go in terms of regulating the financial system. Do we in essence nationalize it, making banking all but a public utility? I fervently hope not. But we have to massively change how we have been regulating and supervising. We have to take better control of the revolutions in technology and globalization. We have to get the fire back in the fireplace.

A New Framework: In order for America to enjoy the benefits of a modern financial system that can allow it to more readily help to build new factories, hospitals, schools and homes, we need a new regulatory framework, one suited to technology-driven finance of the 21st century. Certain elements of that framework are clear.

1. Sound finance must start with fair treatment of the consumer and much higher standards of market conduct. We cannot allow any American to be knowingly sold inappropriate financial products as has just taken place too often in respect of sub-prime and "alt-A" mortgage products. For all the good we are doing to bolster the financial system, we will have won the battle and lost the war if we fail to redouble our commitment to keeping homeowners in their homes.

2. All financial enterprises should be regulated within a unified framework. In other words, financial enterprises engaged in roughly the same activities that provide roughly the same products should be regulated in roughly the same way. The same logic must apply to institutions of roughly the same size—they should be under roughly the same regulatory regime. Just because an institution chooses one charter or one name does not mean it should be able to manipulate the system and find a lower standard of regulation.

3. The U.S. must abandon our alphabet soup of regulators and create a more coherent regulatory service. We have a system that is rooted in a proud history, that includes exceptionally fine and dedicated public servants, and that in many ways has served us well. But it is now beyond debate that a banking framework with its roots in agrarian, 18th century America is in urgent need of a radical, 21st century, global-economy restructuring. However, the secret to effective regulation is not how we move around the boxes. Mashing the alphabet noodles into one incoherent glob will not make the concoction taste any better. What we need is a much more effective regulatory mechanism. We have to take the whole effort up a notch. We have to put the time and energy into determining both what regulations are effective, and what regulations place pure counterproductive and bureaucratic burdens on institutions.

4. We need to professionalize financial services regulation. We have college degrees for everything from carpentry to desktop publishing to commercial fishing, yet we do not have full courses of studies, degrees, chairs at major universities in supervision and regulation. America is in fact blessed with many talented and dedicated examiners and regulators, but this is in too large a measure despite, not because, of our system of on-the-job training for the guardians of our financial system.

5. We need to deleverage the financial system and country as a whole and restrain excess liquidity build-up. In this regard, we have to encourage savings, eliminate the structural federal budget deficit and contain asset price bubbles before they get so large that pricking them brings down the economy.

6. We must reverse the tendency of the last decade to have pro-cyclical regulatory, accounting and other policies. Mark-to-market accounting is clearly flawed and must be materially re-worked.

7. Finally, we need to align financial rewards for executives with the well-being of their companies and the stakeholders they serve. Clearly, financial institution governance is off kilter when we give a king's ransom to traders and other financial executives who have in essence beggared their companies and then walked away from a shipwreck to a comfortable retirement. At the same time, executives who take the wheel, stay with the vessel, and steer it through stormy seas deserve to be fairly compensated.

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