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 Financial Stability Oversight Council Releases First Annual Report

By: Jeffrey A. Goldstein

Today the Financial Stability Oversight Council released its 2011 Annual Report. This is the Council’s first annual report and the first public report ever issued by the U.S. government that provides a comprehensive view of financial market developments, potential threats to financial stability and recommendations for further strengthening the financial system.

This report provides a snapshot of the financial system and potential vulnerabilities. It is also part of an ongoing process by the Council to identify and mitigate potential threats to financial stability. This is an inherently difficult exercise. No financial crisis emerges in exactly the same way as its predecessors, and the most significant future threats will often be the ones that are hardest to diagnose and preempt.

Although we cannot predict the precise threats that may face the financial system, the best way to prepare for the inevitable uncertainty is to continue to build the shock absorbers and other safeguards that improve the resilience of the financial system.

The report identifies three key areas beyond implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act where we believe more needs to be done:

1) Heightened risk management and supervisory attention

  • Construct robust capital, liquidity and resolution plans.
  • Bolster resilience to unexpected interest rate shifts.
  • Maintain discipline in credit underwriting standards.
  • Employ appropriate due diligence for emerging financial products.
  • Keep pace with competitive, technological, and regulatory market structure developments.

2) Reforms to address structural vulnerabilities

  • Implement structural reforms to mitigate run risk in money market funds.
  • Elimination of most intraday credit exposure and reform of collateral practices in the tri-party repo market to strengthen the market.
  • Improve the overall quality of mortgage servicing by establishing national mortgage servicing standards and servicer compensation reform.

3) Continued progress on housing finance

  • To strengthen the housing finance system, the Council member agencies and the Department of Housing and Urban Development should set forth standards and guidelines for participants in the housing finance system, and other actions that strengthen mortgage underwriting.
  • To give further confidence to the market and provide long-term stability to the U.S. financial system, the Council believes Congress must pass responsible legislation to reform the housing finance system. The reform efforts should not further destabilize the fragile housing market.

In addition to recommendations for future action, today’s report includes a discussion of the current state of the U.S. financial system and some of the major forces that will shape its development going forward.

Last week, we marked the one-year anniversary of Dodd-Frank, the most significant set of financial reforms in our lifetimes.

The President signed Dodd-Frank into law because we experienced a financial crisis that delivered a devastating shock to our economy – a shock that many argue was more severe than what precipitated the Great Depression, and one that cost millions of Americans their homes, their savings, and their jobs. Reform was not a choice, it was an obligation.

Dodd-Frank provides a framework to fix the most fundamental problems in the American financial system. As part of that framework, the law established the Council to provide joint accountability for identifying and mitigating potential threats to the stability of the financial system. Congress recognized that financial stability will require the collective engagement of the entire financial regulatory community. The Council, which consists of 10 voting members and five nonvoting members, engages that entire community by bringing together the expertise of policy makers and both federal and state financial regulators.

Three years after the worst financial crisis in generations, our financial system is now on more solid ground, less prone to excessive leverage and risk-taking, more transparent to investors, creditors and regulators, and more resilient to adverse events.

For example, as these charts demonstrate, financial institutions now hold substantially more capital relative to risk than they did before the crisis. 

Greater capital buffers serve as shock absorbers against unexpected losses and future downturns. Financial institutions are also less reliant on sources of short-term funding that can dry up quickly during a crisis. The progress made on these fronts – and that will continue to be made on these fronts – will help make financial shocks less likely and less damaging.

Other areas of progress include:

  • A global agreement on liquidity and capital standards.
  • The ongoing work to create, for the very first time, a comprehensive framework of oversight for the over-the-counter derivatives market, which now has an estimated $600 trillion in gross exposures.
  • A new agency dedicated to protecting consumers.
  • The process to wind down Fannie Mae and Freddie Mac and reform the overall mortgage market has begun.
  • And the completion of most of the emergency actions that were taken to put out the fires of disaster, with most large financial companies that received government support having repaid their obligations. Taxpayers have now collected $10 billion in profit to date from the bank programs. Just two years ago, hundreds of billions in losses were projected on those investments.

The Council and its members will continue to implement Dodd-Frank on a coordinated basis to enhance the integrity, efficiency, transparency, competitiveness and stability of U.S. financial markets.

The report was created collaboratively by the members of the Council and their staff and unanimously approved by the Council. It reflects the Council’s ongoing efforts to monitor risks to financial stability.

Millions of Americans have suffered because of the financial crisis. Many are still suffering. And we owe it to them to build a financial system that has better protections against abuse and catastrophic risk – protections that can adapt to threats that we cannot necessarily predict, preempt or even fully understand.

Jeffrey A. Goldstein is Under Secretary for Domestic Finance.

Posted in:  Financial Stability Oversight Council
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