Thank you, Dean Henry, for that kind introduction, and for your hospitality here today. I also want to thank and acknowledge my friend President Sexton.
It's good to see you and to be here at NYU. And I want to thank the students and other citizens of this great City for being here today.
Last month, President Obama signed into law reforms that will reshape the American financial system and restore it to its core purpose of generating lasting economic growth.
Today, I want to outline the next steps for financial reform and the challenges we face in making these reforms a success.
But before I do, I think it's worth recalling how we got here.
Reform was an obligation, never a choice.
We had an obligation to fix the basic flaws in our financial system that helped trigger the worst global economic crisis since the Great Depression.
We had an obligation to make sure that this great recession would be remembered not just for the deep damage it caused but also for the sweeping change it compelled.
We had an obligation to rebuild our financial system so it could, once again, be an engine for economic growth and innovation.
The battle for financial reform, while hard fought, was a battle of necessity.
For much of the last century, the American financial system was the envy of the world.
Our system provided investors with the strongest protections in the world. Those protections, and our dynamic, competitive market for financial innovation, fueled the global ascendance of American business.
Our system provided the financing that created the great American manufacturing companies; that unleashed a revolution in technology; that led to life saving advancements in science.
And our system provided hundreds of thousands of engineers and entrepreneurs, scientists and small businesses with an unparalleled opportunity to transform their ideas into industries.
Where the American economy excelled relative to other major developed economies – in innovation and in higher productivity growth – it did so, in part, because our financial system was better at directing investment towards the companies and industries where the returns would be highest.
Now, the American financial system achieved all this because we had a strong set of rules governing finance. These regulatory checks and balances helped create a remarkably long period of relative economic stability. Recessions happened, but they were shorter and less damaging. We appeared to have achieved a system that was reasonably stable, but also very good at innovation.
But over time those great strengths of our financial system were undermined. The careful mix of protections we created eventually eroded.
New industries of consumer finance and mortgage lending grew up outside the banking sector, evading rules necessary to protect consumers. Huge amounts of risk moved outside the banking system to where it was easier to increase leverage.
That combined with a long period of low real interest rates around the world, led to a race to the bottom in underwriting standards and credit terms. And, ultimately, it led the American financial system – once the model of efficiency – to misallocate hundreds of billions of dollars towards an unsustainable real estate boom
When things fell apart, the damage spread far beyond Wall Street. Housing prices fell off a cliff. Business and trade halted around the world. Trillions of dollars in savings vanished. Millions of jobs were lost. And thousands of companies across main street America collapsed.
How did this happen? The failures were many.
On Wall Street and across the American financial system, financial firms of all types took on risks they did not fully understand.
In Washington, financial regulators did not sufficiently use the authority they had to protect consumers and limit excessive risk;
policy makers did not act early enough to overhaul a broken system;
and Congress legislated loopholes that allowed large parts of the financial industry to operate without oversight, transparency, or restraint.
And, it is important to remember this. In communities across the country, many Americans took on more debt than they could afford and took on financial risks they did not fully appreciate.
We share responsibility for the crisis, and we share responsibility for reform.
The reforms that are now the law of the land will help us rebuild a pro-growth, pro-investment financial system;
a system that will allow Americans to save for retirement and to borrow to finance an education or a home knowing that proper safeguards are in place to prevent firms from taking advantage of them;
a system that will help businesses finance growth with less risk that they will be starved for credit the next time we face an economic downturn.
Now, to get there, we have different responsibilities.
For the American people, the core challenge is to save a larger share of income, to borrow more responsibly, and to be sure we better understand the risks involved in investing and borrowing.
That process is underway.
Americans are rediscovering the importance of living within their means. They're saving more and paying down debt. And they're growing more careful about how they borrow and how they invest. These changes are necessary and healthy. And they will make us stronger as a country.
For the financial industry, your core challenge is to restore the trust and confidence of the American people and your customers and investors around the world.
You will have to make your own decisions about how best to do that, but, I thought, given that I'm here in New York, I'd offer a few suggestions as an interested observer.
Don't wait for Washington to draft every rule before you start changing how you do business.
Get ahead of the process and out in front of your competitors.
Find new ways to improve disclosure for your consumers. End hidden fees. Don't push people into loans they can't afford.
Demonstrate to your business customers – small and large – that after running for cover during the peak of the crisis you are ready and willing to take a chance on them again.
Change how you pay your executives so you are not rewarding them for taking risks that could threaten the stability of the financial system.
Make sure you have board members who understand your business and the risks you are taking.
And, focus on improving your financial position so that your financial ratings, your cost of capital, the amount you have to pay to borrow, all reflect your own financial strength and earnings prospects, not the false expectation that the government will be there in the future to rescue you.
You can do all of that right now, even before the first new rule of financial reform is written.
But a substantial part of the responsibility for reform, of course, falls on Washington.
Those of us in government – policy-makers, regulators, and supervisors – must make sure that these reforms meet the promise of the law; that these reforms provide both the necessary protections against financial excess and the benefits of financial innovation.
That is our core challenge.
And I want to briefly lay out some of the principles that will guide our work going forward.
First, we have an obligation of speed.
We will move as quickly as possible to bring clarity to the new rules of finance. The rule writing process traditionally has moved at a frustrating, glacial pace. We must change that.
Second, we will provide full transparency and disclosure.
The regulatory agencies will consult broadly as they write new rules. Draft rules will be published. The public will have a chance to comment. And those comments will be available for everyone to see.
Third, we will not simply layer new rules on top of old, outdated ones.
Everyone that is part of the financial system – the regulated and regulators – knows that we have accumulated layers of rules that can be overwhelming, and these failures of regulation were in some ways as appalling as the failures produced where regulation was absent.
So alongside our efforts to strengthen and improve protections for the economy, we will eliminate rules that did not work. Wherever possible, we will streamline and simplify.
Fourth, we will not risk killing the freedom for innovation that is necessary for economic growth.
Our system allowed too much freedom for predation, abuse and excess risk, but as we put in place rules to correct for those mistakes, we have to strive to achieve a careful balance and safeguard the freedom, competition and innovation that are essential for growth.
Fifth, we will make sure we have a more level playing field – not just between banks and non-banks here in the United States – but also between our financial institutions and those in Europe, Japan, China, and emerging markets who are all competing to finance global growth and development. We will do this by setting high global standards and blocking a `race to the bottom' from taking place outside the United States.
Finally, we will bring more order and coordination to the regulatory process, so that the agencies responsible for building these reforms are working together not against each other. This requires us to look carefully at the overall interaction of regulations designed by different regulators and assess the overall burden they present relative to the benefits they offer.
So those are the principles that will guide our implementation of financial reform.
You should hold us accountable for honoring them.
Now, this process is very broad in scope and very complicated. It will take time.
It involves appointing new champions of consumer financial protection and leaders of bank supervision. It involves writing new rules in some of the most complex areas of modern finance. It involves consolidating authority now spread across multiple agencies. It involves setting up new institutions for coordination, crisis management, consumer protection, and for indentifying systemic risks. It involves negotiations with countries around the world.
Each of the agencies involved in implementing financial reform – Treasury, the Federal Reserve, the SEC, the CFTC, the OCC, the FDIC and others – are in the process of outlining how they propose to prioritize the rules they now have to write and setting initial dates for when the public will be able to comment on draft rules.
And in September, when the Financial Stability Oversight Council first meets, we will establish an integrated road map for the first stages of reform and put that in the public domain.
Now, without getting ahead of that process, let me provide you with a brief introduction to the steps we expect to take in four of the most important areas over the next several months.
First, consumer protection.
We want to move quickly to give consumers simpler disclosures for credit cards, auto loans and mortgages, so that they can make better choices, borrow more responsibly, and compare costs.
One of the ways we intend to do that is by combining the two separate and inconsistent federal mortgage disclosure forms that consumers currently get. Next month, we'll convene mortgage companies, consumer advocates, housing counselors and other experts to gather ideas on how to do that. We'll take the best ones, test them on consumers, and then soon be able to unveil a new, easy to understand, federal disclosure form.
In addition, we will be inviting public comment on new national underwriting standards for mortgages, so that we can begin to shape the reforms of the mortgage market.
Now, consumer protection also requires better enforcement, particularly of consumer finance companies not regulated as banks. And so – building on our very successful effort to stop mortgage scams led by a joint task force we created with the Justice Department and State Attorneys General – we are going to coordinate a national enforcement effort targeted at other forms of consumer abuse, including those financial companies that target members of the military and their families. While our soldiers protect our nation abroad, their families should not be exposed to financial abuse at home.
Second, we are moving forward on reforming the GSEs and our broader housing finance system.
Later this month, we will bring together at the Treasury Department leading academic experts, consumer and community organizations, industry participants and other stakeholders for a conference of experts focused on the future of housing finance. We'll use the conference to explore various models of reform and we will seek input from across the political and ideological spectrum.
Chairman Frank plans a series of hearings on housing finance reform this fall. And we are required to submit our plan for reform by January of next year.
Third, we are going to move quickly to begin shaping reforms of the derivatives market. To start the process, we will work with the Fed, the SEC and the CFTC to outline specific quantitative targets for moving the standardized part of the over the counter derivatives business onto central clearing houses. And we must accelerate the international effort to define common global standards for transparency, oversight, and the prevention of manipulation and abuse of these critically important markets.
Now, the final area of reform that I want to talk about is perhaps the most important, establishing new rules to constrain risk taking by – and leverage in – the largest global financial institutions.
All financial crises are, at their core, caused by excess leverage, a term we use to describe the amount of risk firms take relative to the financial reserves they hold against those risks.
Capital requirements determine the amount of loss firms can absorb, the magnitude of the risks they can take without risking failure. They help the market provide discipline by forcing shareholders who enjoy profits in good times to be exposed to losses in bad times.
Capital requirements are the financial equivalent of having speed limits on our highways, antilock brakes and airbags in our cars, and building codes in communities prone to earthquakes.
Part of that made this crisis so severe was that capital requirements failed to keep up with risks and failed to force firms to prepare for the possibility of a very severe recession with a substantial reduction in house prices.
This mistake was made worse by the fact that we allowed a large parallel financial system – composed of investment banks, consumer finance companies, and firms like AIG – to grow up alongside the regulated banking system. In that parallel system, firms were allowed to operate with very thin capital cushions, and to finance their activities with short-term, unstable sources of funding.
Meanwhile, elsewhere in the world, the rules were in some ways even weaker. That was true in the U.K. where – in order to attract business away from New York and Frankfurt – they built a financial system on the unstable foundation of a strategy called "light touch regulation." And that was true in many of the other major developed economies where the rules allowed firms to operate with much lower levels of capital relative to risk.
The global capital framework we had in place ahead of this crisis obviously did not work. And we are moving quickly, across the world, to fix it.
Let me describe the key elements of the international agreement we are working to build.
First, we are going to make sure that financial firms hold a lot more capital than they did before the crisis. We want the new requirements to be set so that we could face a crisis of this severity in the future without the government having to step in and provide emergency life support. The major banks will be required to hold enough capital so they could withstand losses similar to what we saw in the depths of this recession and still have the ability to operate without turning to the taxpayer for help.
Second, we are going to make sure that firms meet these requirements with common equity so that they can better absorb losses. In contrast to the rules prevailing today, which allow a wide range of other forms of capital, the requirements will be set in terms of real common equity, tightly defined to mean capital that will truly absorb first losses when firms get into trouble.
Third, firms will be required to hold significantly more capital against the types of risky trading- related assets and obligations that caused so much unexpected financial damage during the crisis.
Fourth, bigger firms and more complex, interconnected firms will have to hold relatively more capital than smaller firms. The largest and most interconnected firms cause more damage when they fail, so they need to hold more capital against risk. That is based on a principle of fairness and also provides incentives for firms to limit their size and reduce their leverage.
And fifth, new capital requirements will be supplemented with new global standards for liquidity management, so that firms can withstand a severe shock in liquidity without deepening the crisis by, for example, selling assets in a panic or cutting credit lines indiscriminately or needlessly turning to central banks for liquidity support – all of which can undermine financial confidence in periods of stress.
Under the framework now being built, firms will be subject to two tiers of capital requirements.
All firms will need to hold a substantial minimum level of capital. And they will be required to hold an added buffer of capital set above the minimum. If a firm suffers losses that force it to eat into that buffer, it will have to raise capital, reduce dividends, or suspend share repurchases.
This will help make the system more stable over time, in part by forcing banks to move more quickly to strengthen their balance sheets as the risk of potential losses increases.
Now, the most consequential part of this framework will be the new quantitative capital ratios.
We know they need to be substantially higher than they were. But we also know that if we set them too high too fast, we could hurt economic recovery or simply end up pushing risk outside of the banking system, something that could ultimately come back to haunt us.
To limit that potential, we plan to give banks a reasonable transition period.
Banks will have until the beginning of 2013 to meet the new minimum, and will have several years beyond that to build up their new capital buffers while implementing a progressively more stringent definition of what counts as capital. Importantly, that means banks will have the opportunity to meet these new requirements in part through future earnings and that will help protect the recovery currently underway.
For the U.S. financial system, it is important to note that because we moved so quickly, with the bank stress tests in early 2009, to force banks to raise more common equity, our financial system is in a very strong position internationally to adapt to the new global rules.
Now, as I said at the start, enacting Wall Street Reform was a hard fought battle.
And the opponents of reform will continue to claim – as they have over the past year – that these reforms will bring about the end of American enterprise.
Well, let me provide some perspective.
Eight decades ago, a previous generation of Americans battled through a great depression. And four years after the great crash of 1929, they rose to meet the great challenge of their day by establishing bold new bank protections and new securities laws.
At the time, just as now, the opponents of reform predicted grave danger.
In 1933, Time Magazine wrote, in reference to the bill that created the FDIC, "through the great banking houses of Manhattan last week ran wild-eyed alarm. Big bankers stared at one another in anger and astonishment. A bill just passed… would rivet upon their institutions what they considered a monstrous system… such a system, they felt, would not only rob them of their pride of profession but would reduce all U.S. banking to its lowest level."
A year later, in 1934, the President of the Chamber of Commerce, speaking of the Securities Exchange Act said, "it is the opinion not only of Stock Exchange brokers, but of thoughtful business men that its sweeping and drastic provisions would seriously affect the legitimate business of all members of Stock Exchanges and investment banks, with resultant disastrous consequences to the stock market; would greatly prejudice the interest of all investors; would tend to destroy the liquidity of banks and would impose on corporations of the country serious handicaps in the practical operation of their business."
Notwithstanding those fears and distortions, the reforms that followed the Great Depression laid the foundation for decades of prosperity and led to one of the most-impressive records of investment, innovation and growth any major economy had ever seen.
Financial reform cannot just be about fighting the last war. Future risks will look different than those we've seen in the past. And so we need a system that is more adaptable and resilient; one that builds a strong foundation for lasting economic growth.
The reforms we passed will fundamentally reshape the entire financial system. They will require financial firms to change the way they do business, to change the way they treat customers, to change the way they manage risk, and to change the way they reward their executives.
These reforms will be tough, but they will be toughest on those who took the greatest risks; on those who operated closest to the edge of prudence; on those who chased the market down and competed in a race to the bottom in standards and practices; and on those who made most of their profits in the most unsustainable of ways.
And these reforms will benefit American business and the American people, by providing a more stable source of financing for the investments that will drive future gains in income and future growth.
Now, I know that some of you here today are students at this great university.
You have come of age at a time of great national challenge. And, while I know it hasn't been easy, because of that, you will bring to the world not just a greater appreciation for risk and responsibility, but also a recognition that what we bring to the world depends not so much on how much we earn, but on the nature of the work we do. That is a good thing.
America is coming back. The economy is healing. We are repairing the damage caused by the crisis. And we are taking the hard steps now, by implementing reforms that will be essential to our capacity to grow and prosper in the future.
Financial reform will make our financial system stronger, and it will make our economy stronger.