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In the years leading up to the current financial crisis, risks built up
dangerously in our financial system. Rising asset prices, particularly
in housing, concealed a sharp deterioration of underwriting standards
for loans. The nation’s largest financial firms, already highly
leveraged, became increasingly dependent on unstable sources of
shortterm funding. In many cases, weaknesses in firms’ risk-management
systems left them unaware of the aggregate risk exposures on and off
their balance sheets. A credit boom accompanied a housing bubble.
Taking access to short-term credit for granted, firms did not plan for
the potential demands on their liquidity during a crisis. When asset
prices started to fall and market liquidity froze, firms were forced to
pull back from lending, limiting credit for households and
businesses.Our supervisory framework was not equipped to handle a
crisis of this magnitude. To be sure, most of the largest, most
interconnected, and most highly leveraged financial firms in the
country were subject to some form of supervision and regulation by a
federal government agency. But those forms of supervision and
regulation proved inadequateand inconsistent.

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A federally supervised institution would no longer be able to
choose its supervisor based on any consideration of real or perceived
differences in agencies’ approaches to consumer protection supervision
and enforcement. The CFPA should also have the ability to act
comprehensively to address emerging consumer protection concerns. For
example, under the current fragmented structure, the federal banking
agencies took until December 2005 to propose, and then until June 2007
to finalize, supervisory guidance on consumer protection concerns about
subprime and nontraditional mortgages; the worst of these mortgages
were originated in 2005 and 2006. A single agency, such as the CFPA,
could have acted much more quickly and potentially saved many more
consumers, communities, and institutions from significant losses.We
propose that the CFPA’s jurisdiction should cover consumer financial
services and products such as credit, savings and payment products and
related services, as well as the institutions that issue, provide, or
service these products and provide services to the entities that
provide the financial products. The mission of the CFPA would be to
help

ensure that consumers have the information they need to make
responsible financial decisionsThe CFPAshould be structured to promote
its independence and accountability. The CFPA will have a Director and
a Board. The Board should represent a diverse set of viewpoints and
experiences. At least one seat on the Board should be reserved for the
head of a prudential regulator.

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Loan originators failed to require sufficient documentation of income
and ability to pay.Securitizers failed to set high standards for the
loans they were willing to buy, encouraging underwriting standards to
decline. Investors were overly reliant on credit rating agencies.
Credit ratings often failed to accurately describe the risk of rated
products. In each case, lack of transparency prevented market
participants from understanding the full nature of the risks they were
taking.The build-up of risk in the over-the-counter (OTC) derivatives
markets, which were thought to disperse risk to those most able to bear
it, became a major source of contagion through the financial sector
during the crisis.We propose to bring the markets for all OTC
derivatives and asset-backed securities into a coherent and coordinated
regulatory framework that requires transparency and improves market
discipline.

The federal government’s responses to the impending bankruptcy of Bear
Stearns, Lehman Brothers, and AIG were complicated by the lack of a
statutory framework for avoiding the disorderly failure of nonbank
financial firms, including affiliates of banks or other insured
depository institutions. In the absence of such a framework, the
government’s only avenue to avoid the disorderly failures of Bear
Stearns and AIG was the use of the Federal Reserve’s lending authority.
And this mechanism was insufficient to prevent the bankruptcy of Lehman
Brothers, an event which served to demonstrate how disruptive the
disorderly failure of a nonbank financial firm can be to the financial
system and the economy. For these reasons, we propose the creation of a
resolution regime to allow for the orderly resolution of failing BHCs,
including Tier 1 FHCs, in situations where the stability of the
financial system is at risk.This resolution regime should not replace
bankruptcy procedures in the normal course of business.

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