Substituting Regulator Discretion for Regulatory Reform
Apart from the structure of the regulatory regime itself, it is important that investor protection and the fairness of our markets not depend solely on the discretion of regulators. It is important that any regulatory reform put laws on the books that create clear principles that can stand the test of time as cornerstones of a regulatory program.

It is well established that, prior to the financial crisis, regulators had abandoned vigorous governmental oversight and placed their faith in the ability of the markets to self-police and self-correct. Even as the credit crisis unfolded in early 2008, the prevailing view in the industry and among many agencies and government leaders was that too much regulation, rather than too little, was eroding the competiveness of the U.S. markets. In fact, the financial crisis has proven the opposite. It is clear that insufficient and ineffective oversight, rather than over-regulation, facilitated the crisis. As I have spoken about many times, beyond this misplaced faith in the markets, regulators lacked the will, knowledge and resources to respond appropriately to rapid financial innovation and market expansion. When the regulatory structure and those who operate it are so seriously hindered, as we have experienced, systemic risk escalates.

Thus, regulatory reform will not succeed if market participants are engaged in the exact same behavior as before, and regulators are simply encouraged to be more active. This regime would lack a principled core, and it is likely to encourage activity that promotes systemic risk rather than corral it. We do not want regulatory reform that creates, as the well-known financial journalist Steven Pearlstein said, "the kind of complexity, the opportunities for regulatory arbitrage and the lack of accountability that got us into this mess in the first place."

Statutory provisions should be written to affirmatively reduce or eliminate sources of systemic risk. Take, for example, the issue of capital requirements for financial firms. The House Bill authorizes regulators to enforce a simple mandatory leverage limit of 15 to 1, whereas the Senate bill leaves the decision to impose capital requirements to the discretion of regulators. The problem with discretionary authority, of course, is that you need to know when to use it, and you need to have the will to use it when appropriate. Financial journalist, Ezra Klein, recently wrote on this topic and advised that "the trick is building protections that work even when the people in charge don't realize that they're needed."

I agree with Thomas Hoenig, the President of the Federal Reserve Bank of Kansas, who stated that "Congress should mandate simple, easily understood and enforceable rules - rather than guidelines so regulators can restrain and rein in the financial firms." With clear rules in hand, regulators should then be given broad authority to customize these rules. Of course, the regulator should be required to make appropriate findings that the proposed changes are in the public interest and do not increase systemic risk. Given an unpredictable future, regulatory reform will be most effective if rules are straightforward and regulators are empowered to address future needs.

Let's face it - No matter how broad the reach of any new legislation, an army of lawyers will work to find loopholes and to structure products and relationships to fall within the gaps. Regulators must therefore operate from a set of principles and rules that will stand the test of time.