Modernizing the Outdated U.S. Financial Regulatory System

Why It's High Risk

The United States continues to recover from the aftermath of the worst financial crisis in more than 75 years, which led to federal assistance being provided to many firms, including the two large housing-related government sponsored enterprises (GSEs). These events clearly demonstrated that the U.S. financial regulatory system was in need of significant reform.

^ Back to topWhat We Found

During the past few decades, the U.S. financial regulatory system failed to adapt to significant changes.

• First, although the U.S. financial system increasingly became dominated by large interconnected financial conglomerates, no single regulator was tasked with monitoring and assessing the risks that these firms’ activities posed across the entire financial system.
• Second, various entities, such as nonbank mortgage lenders, hedge funds, and credit rating agencies, were not subject to sufficiently comprehensive regulation and oversight, despite their critical roles in financial markets.
• Third, the regulatory system was not effective at providing key information and protections for new and more complex financial products for consumers and investors.

Making changes that better position regulators to oversee firms and products that pose risks to the financial system and consumers and to adapt to new products and participants as they arise is essential to reduce the likelihood that the financial markets will experience another financial crisis similar to the most recent one. Losses from risky mortgage products also resulted in the each of the two large housing-related GSEs being placed into government conservatorship.

In the last year, policymakers have taken significant actions intended to reform the U.S. financial regulatory system to address the risks associated with evolving financial firms, markets, and products. After considerable debate within the administration and Congress, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) was enacted. The act’s reforms aim to better position the financial regulatory system in areas addressing the changes and risks that GAO identified.

• A new Financial Stability Oversight Council made up of the various financial regulators was created to identify risks to U.S. financial stability, including risks posed by large, interconnected financial conglomerates. Reducing the potential for systemic risk posed by the interconnectedness of firms was also addressed by new requirements for many over-the-counter derivatives to be cleared through clearinghouses and traded on exchanges.
• Additional requirements and oversight have also been placed on hedge funds, credit rating agencies, and other market participants previously subject to less regulation.
• A new Bureau of Consumer Financial Protection has been created to have broad regulatory responsibilities for mortgage loans and other consumer financial products, although securities, futures, and insurance products are exempt.

^ Back to topWhat Needs to Be Done

The Dodd-Frank Act includes many provisions that are intended to improve the U.S. financial regulatory system. However, many of the act’s changes, including new regulatory structures, agencies, and requirements, are yet to be implemented, and many decisions by regulators as to how new regulations will address various problem areas are forthcoming. For example, the new oversight council has only recently begun meetings to fulfill its mission. Similarly, financial regulators have yet to develop and issue many of the rules necessary to fully implement various changes, including those related to proprietary trading, trading and clearing of over-the-counter derivatives, and others. Until these new structures, requirements, and entities are in place, fully staffed, and functioning effectively, the act’s intent to reform the financial system will not be achieved. Policymakers also must determine how to reform the housing GSEs and the extent of government involvement in housing finance going forward.

^ Back to topKey Reports

Troubled Asset Relief Program

Financial Regulation

Fannie Mae and Freddie Mac

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