Overhauling the System
| Author | Randall Dodd |
| Position | Senior Financial Sector Expert in the IMF’s Monetary and Capital Markets Department |
| Pages | 32-34 |
Page 32
United States proposes most radical reform of financial regulation since the New Deal
THE global financial crisis has had a devastating impact on major financial markets, undermining the solvency of firms, disrupting trading liquidity, and forcing a rethinking of prudential regulation. The crisis has made these markets candidates for radical regulatory change. Whereas the regulatory focus had been on the soundness of individual banks, the crisis has shown the need to deal with the financial system as a whole, and such a systemic approach requires the proper regulation of the markets and of the transactions that reflect the interconnections between banks and other financial firms.
The change in approach is reflected in proposed regulatory standards from the Financial Stability Board, the International Organization of Securities Commissions, and such private organizations as the Group of 30 and the Institute of International Finance. Recent proposals from the U.S. Treasury Department reflect similarly fundamental changes in the approach to financial market regulations. The proposals must still be drafted into legislation and approved by the U.S. Congress. But if legislators make few major changes, the Treasury proposals would become the first major overhaul of the U.S. financial system since the New Deal policies during the administration of President Franklin D. Roosevelt, when the world also faced a monumental economic crisis.
Over a seven-year period, starting in 1933, the United States reshaped the regulation of the market structures for banking, securities, derivatives, and mortgage and asset management (see box). New laws transformed the U.S. financial system from one plagued by fraud and frequent crises to one that set the world standard for stability, efficiency, and the ability to raise capital.
The key pieces of legislation ranged across many issues and the various financial sectors, but they are best understood when collected into categories that reflect their basic insights into markets: systemic stability, regulatory reorganization, transparency, enhancing market integrity, and reducing conflicts of interest.
Systemic stability. The Glass-Steagall Act separated traditional commercial banking activities—essentially lending and deposit-taking—from those conducted by securities broker-dealers—such as underwriting, acting as a dealer (market making), and investing in corporate stocks and bonds. As a result, the exposures of banks to cyclical fluctuations that affect securities were reduced, leaving banks more likely to be able to lend during recessions and recovery stages of the cycle. Other legislation required that certain commodity futures be traded on regulated exchanges and subjected trading in these markets to speculative position limits. The higher standard for margin (that is, collateral) at futures exchanges resulted in counterparty and market risks being more prudentiallyPage 33 buffered against loss. The securities acts were also designed to reduce excess volatility and provide greater market stability.
Reorganization. The Securities and Exchange Commission (SEC) was created to regulate and oversee securities markets and the asset management industry; the Federal Deposit Insurance Corporation (FDIC) was created to insure bank deposits. Substantial changes were made to the governance of the Federal Reserve System, including the make-up of the Board of Governors and the...
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