Testimonies

Covered bonds are on‐balance sheet, asset‐backed financing instruments. They are viewed as highly secure “gilt‐edged” investments. Investors have dual recourse, both to the pool of pledged assets that collateralize, or cover, the bond and to the issuer if the proceeds realized from the cover pool are inadequate. Covered bonds differ by country, with the features being determined by both law and regulation. Several countries around the world are working to introduce enabling covered bond legislation, which will assist the product as a new mortgage funding option.

We are now at the first anniversary of Mr. Madoff’s arrest, and, disappointingly, very little has been done to prevent future Madoffs. But future Madoffs are predictable. Annual losses from Ponzi schemes in the U.S. appear to regularly exceed $1 billion, and, prior to Mr. Madoff, the record year was 2002 when losses exceeded $9.6 billion.1 That level of loss justifies more serious reforms than have yet been adopted by the SEC.

We are now facing historic levels of homes lost through foreclosures. Not every individual foreclosure can or should be stopped, but there is an urgent need to stop the epidemic by closing the growing chasm between prevention and losses. Without stronger policy intervention, not only will millions of families lose their homes unnecessarily, but massive foreclosures will continue to destroy communities, drag down the housing market, and keep a full economic recovery out of reach.

Just last week we learned from the F.D.I.C. that lending by U.S. banks plunged by 3 percent in the third quarter, the largest drop since at least 1984 when this kind of information was first collected. This represents the fifth consecutive quarter in which banks have reduced lending. According to the report, banks reduced the amount of money extended to their customers by $210 billion between July and September, cutting back in almost every category, from mortgage lending to business lending.

Without asking for their consent, banks and credit unions unilaterally permit most customers to
borrow money from the bank by writing a check, withdrawing funds at an ATM, using a debit
card at the point of sale, or preauthorizing an electronic payment that exceeds the funds available
in a checking account. Instead of rejecting the debit card purchase or ATM withdrawal at no
cost to the consumer, or returning the check unpaid with a bounced check fee, most institutions
will now cover the overdraft and impose an expensive fee for each transaction.

Over the past few decades, we have seen the significant growth of large, highly leveraged
financial firms. These firms benefited from the perception that the government could not afford
to let them fail, creating a classic moral hazard problem.
During the recent financial crisis, in order to preserve the stability of the financial system, protect
the savings of Americans and prevent greater economic fallout, the government was forced to
step in and stand behind almost all of these firms.

Economists have been studying the subject of interchange fees and related practices since the early 1980s. There has been a flurry of research in the last decade. Much of the research is based on a new field of economics known as two-sided markets. This field studies businesses that create value by bringing different kinds of customers together. A stock exchange, for example, brings liquidity providers and liquidity takers together while a matchmaking service brings men and women together.

We embark upon this reform effort as the financial industry has become ever more concentrated. Given the events of the last decade, there are fewer providers of financial services today. There may be 15 to 20 large complex financial institutions that are at the center of today’s global derivatives marketplace. Five to ten years from now, it is quite possible that the financial system will become even more concentrated. With fewer actors on the stage, it is especially important that we lower the risk of these participants and bring sunshine to the activities in which they are involved.

In the wake of the events of the last two years, all of us involved in regulating the financial markets must take a hard and honest look at our programs and approaches, and search for ways to more effectively uncover misconduct and enhance investor protection.

First, legislative change is needed to ensure that systemically important financial firms are subject to effective consolidated supervision, whether or not the firm owns a bank. Second, an oversight council made up of the agencies involved in financial supervision and regulation should be established, with a mandate to monitor and identify emerging risks to financial stability across the entire financial system, to identify regulatory gaps, and to coordinate the agencies’ responses to potential systemic risks.