Policy Briefing NANCY BENNETT
Here Come the Feds
Enter the federal government into
the regulation of insurance.
Although theories abound, there’s
no consensus regarding the root causes
of the current ecomonic crisis. In my
opinion, it all goes back to a lack of both
institutional and personal integrity.
Integrity is defined as the adherence
to moral and ethical principles or the
soundness of moral character. As applied
to this financial meltdown, I consider integrity to mean taking responsibility for
one’s decisions and accepting the consequences of those decisions. Consider the
following contributory factors:
■ Too much or too little regulation, or
the failure to enforce regulations, including an unregulated credit default
swap market, regulatory failure in detecting fraud and deceptive practices
and gaps in regulatory oversight due to
a patchwork of regulators governing financial institutions;
■ Legislation or regulations that are designed to promote public policy within
the financial markets but don’t consider
the systemic implications on the larger
■ Markets and transactions with a high
degree of correlation or interdependence;
■ Misguided or misunderstood accounting rules;
■ High levels of leverage;
■ High or rapidly increasing concentrations of risk;
■ Lack of appreciation for systemic risks;
■ Mispriced risk reflected in security
■ Misalignment of compensation with
We neeD no reminDer of tHe Pain anD HavoC
caused by the current recession. While no one can accurately predict when it will end or if we will operate differently in the future, one
thing seems certain—politicians are unlikely to ignore rahm emanuel,
President obama’s chief of staff, who has advised that you should never let a serious crisis to go to waste.
■ The failure of enterprise risk
management (ERM) in financial institutions, including the development
of overly complex products with misunderstood risks, an overconfidence
in poorly constructed models, and an
overreliance on rating agencies rather
than independent ratings review.
Each of these factors involved an
individual, corporation, regulator, or
politician acting out of self-interest,
with little or no regard for the impact
on others. And once the dominoes started to fall, these individuals or groups
were all looking for a bailout or someone else to blame.
There are many players involved with
regulatory reform, including federal
and state legislators, functional regulators, trade and professional groups,
lobbyists, and international groups with
influence over U.S. financial reform.
Many have suggested principles upon
which regulatory reform should be
based. Others have put forth proposals
to revamp the regulatory framework.
In all of these discussions, we can find
■ Scope—Should reform encompass
all financial-service sectors, including banking, brokerage, insurance, and
securities? Should it streamline the current regulatory patchwork quilt? Should
it close current regulatory gaps, such as
■ ERM effectiveness—How much can
and should regulation influence the
effectiveness of ERM practices? This
includes looking at countercyclical capital requirements, stricter regulation of
systemically significant firms, a requirement for originators to retain some risk
in a securitization transaction, and compensation guidelines that align risk and
return over the long term.
■ Timing—When should government
intervene with failing or failed institutions? And which agency?
■ Systemic risk—What is the role of the
federal government in regulating systemic risks? Is it even feasible?
■ Consumer confidence—How to restore investor and consumer confidence
in the financial markets?
■ International implications—To what
degree will the reform framework converge with international practices?
■ Jurisdiction—Will states or the federal government be charged with new
powers? And if it’s the federal government, which agency?
■ Mission creep—Does the proposed
regulatory framework overreach by creating regulation for sectors that haven’t
been problematic in the past?
■ Compliance—What are the costs of
compliance? How will additional capital
requirements affect returns as both the
level and cost of capital could be affected
for some companies?