	Today’s Financial Regulatory System Was Built over the Course of More Than a Century, Largely in Response to Crises or Market Developments

As a result of 150 years of changes in financial regulation in the United  States, the regulatory system has become complex and fragmented. Today,  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, and hundreds  of state financial regulatory agencies. Changes in Financial Institutions and Their Products Have Significantly Challenged the U.S. Financial Regulatory System

Several key developments in financial markets and products in the past  few decades have significantly challenged the existing financial regulatory  structure. Regulators have struggled, and often failed, to mitigate the  systemic risks posed by these conglomerates, and to ensure they  adequately manage their risks. A second dramatic development in U.S. financial markets in recent  decades has been the increasingly critical roles played by less-regulated  entities. In particular, the increasing prevalence of new and more complex  investment products has challenged regulators and investors, and  consumers have faced difficulty understanding new and increasingly  complex retail mortgage and credit products. Fourth, standard setters for accounting and financial regulators have faced  growing challenges in ensuring that accounting and audit standards  appropriately respond to financial market developments, and in  addressing challenges arising from the global convergence of accounting  and auditing standards. Finally, with the increasingly global aspects of financial markets, the  current fragmented U.S. regulatory structure has complicated some efforts  to coordinate internationally with other regulators. A Framework for Crafting and Assessing Alternatives for Reforming the U.S. Financial Regulatory System

As a result of significant market developments in recent decades that have  outpaced a fragmented and outdated regulatory structure, significant  reforms to the U.S. regulatory system are critically and urgently needed. The current system has important weaknesses that, if not addressed, will  continue to expose the nation’s financial system to serious risks. Our report offers a framework for crafting and  evaluating regulatory reform proposals; it consists of the following nine  characteristics that should be reflected in any new regulatory system. By  applying the elements of this framework, the relative strengths and  weaknesses of any reform proposal should be better revealed, and  policymakers should be able to focus on identifying trade-offs and  balancing competing goals. Similarly, the framework could be used to  craft proposals, or to identify aspects to be added to existing proposals to  make them more effective and appropriate for addressing the limitations  of the current system. 1. 2. As we noted in our report, gaps in the current  level of federal oversight of mortgage lenders, credit rating agencies, and  certain complex financial products such as CDOs and credit default swaps  likely have contributed to the current crisis. 3. Efficient and effective. Key issues to be addressed:    Consider the appropriate role of the states in a financial regulatory  system and how federal and state roles can be better harmonized. Such efforts are under way in other jurisdictions. Washington, D.C.: January 8, 2009.
Why GAO Did This Study

This testimony discusses GAO's January 8, 2009, report that provides a framework for modernizing the outdated U.S. financial regulatory system. GAO prepared this work under the authority of the Comptroller General to help policymakers weigh various regulatory reform proposals and consider ways in which the current regulatory system could be made more effective and efficient. This testimony (1) describes how regulation has evolved in banking, securities, thrifts, credit unions, futures, insurance, secondary mortgage markets and other important areas; (2) describes several key changes in financial markets and products in recent decades that have highlighted significant limitations and gaps in the existing regulatory system; and (3) presents an evaluation framework that can be used by Congress and others to shape potential regulatory reform efforts.

What GAO Found

The current U.S. financial regulatory system has relied on a fragmented and complex arrangement of federal and state regulators--put into place over the past 150 years--that has not kept pace with major developments in financial markets and products in recent decades. Today, almost a dozen federal regulatory agencies, numerous self-regulatory organizations, and hundreds of state financial regulatory agencies share responsibility for overseeing the financial services industry. As the nation finds itself in the midst of one of the worst financial crises ever, it has become apparent that the regulatory system is ill-suited to meet the nation's needs in the 21st century. Several key changes in financial markets and products in recent decades have highlighted significant limitations and gaps in the existing regulatory system. First, regulators have struggled, and often failed, to mitigate the systemic risks posed by large and interconnected financial conglomerates and to ensure they adequately manage their risks. Second, regulators have had to address problems in financial markets resulting from the activities of large and sometimes less-regulated market participants--such as nonbank mortgage lenders, hedge funds, and credit rating agencies--some of which play significant roles in today's financial markets. Third, the increasing prevalence of new and more complex investment products has challenged regulators and investors, and consumers have faced difficulty understanding new and increasingly complex retail mortgage and credit products. Fourth, standard setters for accounting and financial regulators have faced growing challenges in ensuring that accounting and audit standards appropriately respond to financial market developments, and in addressing challenges arising from the global convergence of accounting and auditing standards. Finally, as financial markets have become increasingly global, the current fragmented U.S. regulatory structure has complicated some efforts to coordinate internationally with other regulators. These significant developments have outpaced a fragmented and outdated regulatory structure, and, as a result, significant reforms to the U.S. regulatory system are critically and urgently needed. The current system has significant weaknesses that, if not addressed, will continue to expose the nation's financial system to serious risks. Our report offers a framework for crafting and evaluating regulatory reform proposals consisting of nine characteristics that should be reflected in any new regulatory system. By applying the elements of the framework, the relative strengths and weaknesses of any reform proposal should be better revealed, and policymakers should be able to focus on identifying trade-offs and balancing competing goals. Similarly, the framework could be used to craft proposals, or to identify aspects to be added to existing proposals to make them more effective and appropriate for addressing the limitations of the current system.