03 July 2008

Treasury Paulson calls for regulatory overhaul

'We need to design carefully and put in place a stronger capacity for resolution and crisis intervention that re-inforces market discipline', Treasury Secretary Paulson said. 'Financial institutions must be allowed to fail'.

We should create a system that gives us the best chance of foreseeing a crisis, including a market stability regulator with the authorities to avert systemic issues it foresees and providing the information, tools and authorities to deal better with unexpected events, Treasury Secretary Henry Paulson said.

 

We need to design carefully and put in place a stronger capacity for resolution and crisis intervention that re-inforces market discipline, Paulson said. “Financial institutions must be allowed to fail”, he continued underlining that under optimal financial regulatory and financial system infrastructures, such a failure would not threaten the overall system.

 

The balkanized U.S. financial regulatory system is outdated, he reiterated.  The new model currently under discussion proposes three primary regulators: one focused on market stability across the entire financial sector, another focused on safety and soundness of institutions supported by a federal guarantee, and a third focused on protecting consumers and investors.

 

When it comes to regulatory intervention, the two main concerns relate to the perception that an institution may be too interconnected to fail or too big to fail, Paulson said. “We must take steps to reduce the perception that this is so - and that requires that we reduce the likelihood that it is so.”

 

Measures include strengthening market infrastructure in order to reduce the expectation that an institution is too interconnected to fail, he outlined. To address the perception that some institutions are too big to fail, we must improve the tools at our disposal for facilitating the orderly failure of a large complex financial institution.

“We need to create a resolution process that ensures the financial system can withstand the failure of a large complex financial firm”, he said. “To do this, we will need to give our regulators additional emergency authority to limit temporary disruptions.”

 

“The real issue is not that an institution is too big or too interconnected to fail, but that it is too big or interconnected to liquidate quickly”, Paulson said citing former Federal Reserve Chairman Alan Greenspan.

 

Full speech

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