GAO, G30 Issue Recommendations on Fixing an Ailing Financial System

Shoring up the U.S. financial system was the main focus of two key reports that were issued in January, each of which proposed significantly different courses of action to accomplish that goal. 

On Jan. 15, the Group of 30 (G30) issued Financial Reform:  A Framework for Financial Stability, which addresses flaws in the global financial system and provides specific recommendations to strengthen the oversight and stability of the institutions responsible for maintaining the market infrastructure.

G30 is a private, nonprofit, international body composed of senior representatives of the private and public sectors and academia, led by Paul Volcker, former Federal Reserve chairman and key economic advisor to President Obama.  In its report, the organization proposed a framework for the reform of the global financial system, including a call to eliminate gaps in regulation, increase coordination among international supervisors and enhance surveillance of the core financial institutions. 

“The issue posed by the present crisis is crystal clear:  How can we restore strong, competitive, innovative financial markets to support global economic growth without once again risking a breakdown in market functioning so severe as to put the world economies at risk?” said Volcker in a prepared statement. 

The G30 report laid out four core recommendations:

• Eliminate gaps and weaknesses in the coverage of prudential regulation and supervision, including subjecting all systemically significant financial institutions, regardless of type, to an appropriate degree of prudential oversight
• Improve the quality and effectiveness of prudential regulation and supervision, which will require better-resourced prudential regulators and central banks operating within structures that afford much higher levels of national and international policy coordination
• Strengthen institutional policies and standards, with particular emphasis on standards for governance, risk management, capital and liquidity.  Regulatory policies and accounting standards must also guard against procyclical effects and be consistent with maintaining prudent business practices
• Make financial markets and products more transparent, with better-aligned risk and prudential incentives, and make the infrastructure supporting such markets more robust and resistant to potential failures of even large financial institutions

Among the 18 specific recommendations made by the G30 was to limit the size and scope of banks by prohibiting them from managing hedge or private equity funds.  The report also calls for the operation of major mutual funds as commercial banks, which would subject them to increased government oversight, and for venture capital groups and rating agencies to be subject to increased government regulation.

The proposal also suggests that the U.S. government should clarify the status of Fannie Mae and Freddie Mac, by either making them government agencies or regulating them as independent mortgage brokers. 

“We hope that our proposals, which explicitly relate to the weaknesses that have become evident in the financial system over the last year, will be a useful contribution to the debate about needed reforms both by private financial institutions and by public authorities,” said Volker.

Just days before the G30 report was released, the U.S. Government Accountability Office (GAO) issued its own recommendations for shoring up the nation’s financial regulatory system.  In Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System, the GAO noted that the current system has relied on “fragmented and complex arrangements 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,” the report states.

The GAO notes several key changes in financial markets that have highlighted the significant limitations and gaps in the existing regulatory system.  These include:

• A failure by regulators to mitigate the systemic risks posed by large and interconnected financial conglomerates and to ensure they adequately manage their risks 
• 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
• Difficulty regulating and even understanding new and increasingly complex investment products, such as retail mortgage and credit products
• Growing challenges faced by standard setters for accounting and financial regulators 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
• A fragmented U.S. regulatory structure that has complicated efforts to coordinate internationally with other regulators

The GAO goes on to propose a framework for crafting and evaluating regulatory reform proposals that consists of nine characteristics that should be reflected in any new regulatory system, including:
 

       1.    Clearly defined regulatory goals
       2.    Appropriately comprehensive
       3.    System wide focus
       4.    Flexible and adaptable
       5.    Efficient and effective
       6.    Consistent with consumer and investor protection
       7.    Regulators provided with independence, prominence, authority and accountability
       8.    Consistent financial oversight
       9.     Minimal taxpayer exposure

“By applying the elements of this framework, the relative strengths and weaknesses of any reform proposal should be better revealed, and policymakers should be able to focus on identifying trade-offs and balancing competing goals.  Similarly, the framework could be used to craft proposals, or to identify aspects to be added to existing proposals to make them more effective and appropriate for addressing the limitations of the current system,” stated the report.

The full G30 report is available at www.group30.org. 

The GAO report is available at http://www.gao.gov/new.items/d09310t.pdf. 

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