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. 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. A second development has been the emergence of large and  sometimes less-regulated market participants, such as hedge funds and  credit rating agencies, which now play key roles in our financial markets. Finally, despite the increasingly global aspects of financial  markets, the current fragmented U.S. regulatory structure has complicated  some efforts to coordinate internationally with other regulators. Largely as the result of waves of mergers and consolidations, the number  of financial institutions today has declined. Based on a worldwide sample of the top 500 financial  services firms in assets, the study found that the percentage of the largest  financial institutions in the United States that are conglomerates— financial institutions having substantial operations in more than one of the  sectors (banking, securities, and insurance)—increased from 42 percent of  the U.S. financial institutions in the sample in 1995 to 62 percent in 2000. Existing Regulatory System Failed to Adequately Address Problems Associated with Less-Regulated Entities That Played Significant Roles in the U.S. Financial System

A second dramatic development in U.S. financial markets in recent  decades has been the increasingly critical roles played by less-regulated  entities. Increased Complexity and Other Factors Have Challenged Accounting Standard Setters and Regulators

As new and increasingly complex financial products have become more  common, FASB and SEC have also faced challenges in trying to ensure  that accounting and financial reporting requirements appropriately meet  the needs of investors and other financial market participants. Standard setters and regulators also face new challenges in dealing with  global convergence of accounting and auditing standards. A Framework for Crafting and Assessing Alternatives for Reforming the U.S. Financial Regulatory System

The U.S. regulatory system is a fragmented and complex system of federal  and state regulators—put into 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. In 2008, the United States finds  itself in the midst of one of the worst financial crises ever, with instability  threatening global financial markets and the broader economy. While  much of the attention of policymakers understandably has been focused  on taking short-term steps to address the immediate nature of the crisis,  attention has also turned to the need to consider significant reforms to the  financial regulatory system to keep pace with existing and anticipated  challenges in financial regulation. As noted earlier, with multiple regulators primarily  responsible for individual institutions or markets, none of the financial  regulators is tasked with assessing the risks posed across the entire  financial system by a few institutions or by the collective activities of the  industry. Comments from Agencies and Other Organizations, and Our Evaluation

We provided the opportunity to review and comment on a draft of this  report to representatives of 29 agencies and other organizations, including  federal and state financial regulatory agencies, consumer advocacy  groups, and financial service industry trade associations. All  reviewers provided valuable input that was used in finalizing this report. In general, reviewers commented that the report represented a high-quality  and thorough review of issues related to regulatory reform. For example, we enhanced our discussion of  weaknesses in regulators’ efforts to oversee the sale of mortgage products  that posed risks to consumers and the stability of the financial system, and  we made changes to the framework to emphasize the importance of  consumer protection. Appendix I: Scope and Methodology

Our report objectives were to (1) describe the origins of the current  financial regulatory system, (2) describe various market developments and  changes that have raised challenges for the current system, and (3) present  an evaluation framework that can be used by Congress and others to craft  or evaluate potential regulatory reform efforts going forward.
Why GAO Did This Study

The United States and other countries are in the midst of the worst financial crisis in more than 75 years. While much of the attention of policymakers understandably has been focused on taking short-term steps to address the immediate nature of the crisis, these events have served to strikingly demonstrate that the current U.S. financial regulatory system is in need of significant reform. To help policymakers better understand existing problems with the financial regulatory system and craft and evaluate reform proposals, this report (1) describes the origins of the current financial regulatory system, (2) describes various market developments and changes that have created challenges for the current system, and (3) presents an evaluation framework that can be used by Congress and others to shape potential regulatory reform efforts. To do this work, GAO synthesized existing GAO work and other studies and met with dozens of representatives of financial regulatory agencies, industry associations, consumer advocacy organizations, and others. Twenty-nine regulators, industry associations, and consumer groups also reviewed a draft of this report and provided valuable input that was incorporated as appropriate. In general, reviewers commented that the report represented an important and thorough review of the issues related to regulatory reform.

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. As the nation finds itself in the midst of one of the worst financial crises ever, the regulatory system increasingly appears to be ill-suited to meet the nation's needs in the 21st century. 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. Much of this structure has developed as the result of statutory and regulatory changes that were often implemented in response to financial crises or significant developments in the financial services sector. For example, the Federal Reserve System was created in 1913 in response to financial panics and instability around the turn of the century, and much of the remaining structure for bank and securities regulation was created as the result of the Great Depression turmoil of the 1920s and 1930s. 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. The portion of firms operating as conglomerates that cross financial sectors of banking, securities, and insurance increased significantly in recent years, but none of the regulators is tasked with assessing the risks posed across the entire financial system. 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. Regulators failed to adequately oversee the sale of mortgage products that posed risks to consumers and the stability of the financial system. 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, despite the increasingly global aspects of financial markets, the current fragmented U.S. regulatory structure has complicated some efforts to coordinate internationally with other regulators.