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The Financial Crisis and Challenges for Regulators

SRCAs the financial turmoil of 2008 increased uncertainty, undermined confidence, and tightened credit conditions for households and businesses, the Federal Reserve has been a key player in providing liquidity and calming markets. And the Philadelphia Fed has done its part.

In fact, while the Third District has weathered the crisis better than other parts of the nation, many Philadelphia Fed employees have invested long hours and extra effort to help ensure that the Federal Reserve System has the resources to meet the challenges. One area with a major role in the response has been the Bank's Supervision, Regulation and Credit Department (SRC).

All of SRC's major units saw increased activity in 2008, especially those related to credit risk management, examination, surveillance, and enforcement.

"One of the consequences of any financial crisis is a heightened focus on the role of the regulator," said Michael E. Collins, executive vice president and lending officer, who leads SRC. "Our goal as financial regulators is to ensure that financial institutions operate in a safe and sound manner as they conduct their business. This includes avoiding market excesses as they manage innovations in their products and services. Our success in dealing with the current crisis will be measured largely by the restoration of public trust and confidence in financial markets and institutions." Collins notes that regulators have responded quickly and aggressively in this crisis, which has helped avoid the large-scale failures seen in the savings and loan crisis of the 1980s or the Great Depression. And while the Third District has not had many financial institution failures, SRC has responded to calls for assistance from other Federal Reserve Districts and the state of Pennsylvania's bank regulators.

He noted that, apart from the crisis, SRC also had to expand staff in 2008 to handle the increased workload associated with the relocation of a large bank holding company to the Third District. SRC's consumer compliance function also responded to the crisis, not only by heightening its focus on compliance with credit card and mortgage regulations but also by publishing a new System-wide newsletter, Consumer Compliance Outlook®, dedicated to consumer compliance issues in the financial industry.

Collins notes that financial crises do not happen overnight. The events that transpired over the past months have long roots — grounded in rapid growth of credit, excessive leverage, poor underwriting, and an influx of new financial products that involved complex and misunderstood risks. He said reshaping the regulatory landscape will take time, but debate and discussion about regulatory reforms are underway.

"Going forward, regulators will strive to find the right balance between regulation and market innovation. A key objective will be to close gaps in the oversight of financial institutions and markets and to update and modernize the regulatory system to keep pace with market realities and global integration," he added. "Regulators will look to improve the capacity of supervisors to identify risks while curbing excessive leverage and risk taking. Valuations of financial institutions' assets will also need to be addressed, such as how to price illiquid assets in a mark-to-market accounting framework."

Many people are aware that the core supervision area has increased its oversight and guidance of Third District financial institutions. Many are familiar with SRC's discount window operations, which have increased the flow of liquidity in the Third District. But what many people may not know is that SRC employees have played an instrumental role beyond the Third District in helping the Board of Governors and other Reserve Banks deal with numerous supervision issues.

Philadelphia's staff of experienced examiners has been a valuable resource to the System through these difficult economic times. Here's how several employees in SRC lent their expertise to the System during the crisis.

Recently, the Board of Governors asked supervising examiner Jim Adams to help with training about how banks handle commercial real estate issues. Adams visited the Federal Reserve Bank of Richmond and the Denver Branch of the Federal Reserve Bank of Kansas City to conduct training for bank examiners. Adams also shared his expertise with the Miami Branch of the Federal Reserve Bank of Atlanta, where he helped conduct a target review of a troubled bank.

Larry Cordell, special advisor in SRC's Retail Risk Analysis unit, was invited to Washington to give a presentation on risks in the home equity market to Federal Reserve Chairman Ben Bernanke. He also worked for the Board as part of a team sent to the Federal Housing Finance Agency (FHFA), the successor agency to the Office of Federal Housing Enterprise Oversight (OFHEO), to examine the books of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac during the financial crisis. Treasury and the FHFA ultimately decided to place the GSE s into conservatorship. In addition, Cordell headed up the business group that worked with the Kansas City Fed's Research Automation Group to build a major data warehouse of mortgage loan data, with over 107 million mortgage loans (35 million active) that cover about two-thirds of the total mortgage market. His group was charged with helping create the data warehouse used by the System for research and to report on current mortgage conditions.

Assistant examiner Reginald Rountree was called on to work with the Federal Reserve Bank of Atlanta, examining the loan portfolios of a large bank in Atlanta's District. The bank was trying to assist borrowers in maintaining their large real estate development loans until the economic crisis subsides, and Rountree's job was to determine whether the borrowers were in a financial position to pay back the loans.

These are just three examples of how the Philadelphia Fed's Supervision, Regulation and Credit Department will continue to provide leadership and insight in the areas of consumer protection and mortgage markets as we continue to work through the current crisis.

"During an economic contraction, we need to oversee financial institutions more diligently and to counsel institutions in need," said Collins. "As the crisis subsides, in its wake will emerge stronger institutions — more productive and viable than before."